Parliament eyes Riksbank's off-mark inflation forecasts

The Riksbank's inflation projections for 2013 missed the mark by a wider degree than outside forecasters, according to a recent report that grades the bank's performance in setting monetary policy, adding to a pattern that in the past year has seen central banks misjudge central economic developments that influence policy.

The report, which serves as the basis for a yearly examination of the bank's monetary policy performance by the Swedish parliament, also notes that the Riksbank on average did a worse job predicting inflation than 10 other examined forecasters over the past seven years.

"The forecasts the Riksbank made in 2011 overestimated both growth and inflation in 2013," the report notes, adding that in the year up to the autumn of 2012, the central bank was among the forecasters whose projections for both inflation and the repo rate – the Riksbank's benchmark rate – were furthest from the final outcome.

The accuracy of Consumer Price Index (CPI) forecasts "reflects a lower relative level of accuracy for the forecasts of the repo rate", the report warns, adding moreover that monetary policy could have been "more expansionary" with hindsight.

Grégory Claeys, a resident scholar at Brussels-based think-tank Bruegel, said he was surprised that the Swedish legislature examines monetary policy on an annual basis, calling it a "good thing". He said there were no apparent downsides to such a practice, "because it doesn't change anything with regard to independence".

Claeys, a co-author of 'European Central Bank accountability: how the monetary dialogue could be improved', a research paper published earlier this month that deals with similar issues within the eurozone, believes the European Parliament should adopt similar mechanisms.

While European Central Bank (ECB) officials give testimonies and partake in Q&A sessions before the European Parliament, these do not amount to a qualitative assessment of the central bank's performance, according to Claeys. The ECB is "not really accountable", he argued, but added the bank was "moving in the right direction". Claeys was not certain, however, that the practice of essentially grading forecasts was feasible, even though "bad forecasts impact on interest rates".

"It's difficult to grade central bank's ability to do forecasts," he said, adding they cannot be faulted for them because they are only indirectly part of mandates to maintain price stability.

‘Very careful not to use words like change'

The Swedish report gave the Riksbank some praise by suggesting it produced "relatively good" forecasts of GDP growth, unemployment and CPIF inflation – a measure of inflation that holds interest rates constant. It also notes that last year's low inflation is partly the result of a sluggish global economy and that other central banks have not fared much better in their predictions.

"It is worth noting that inflation has not only been low in Sweden, but in many other countries too," the report states, adding it appears to be "the rule rather than the exception" that inflation undershot central banks' targets in 2013.

Several major central banks have come under fire in recent months for what their critics describe as an inability to gauge the trajectories of their economies. In Europe, inflation has undershot the ECB's inflation target and forecasts, while in the UK and the US the unemployment rate has fallen faster than the central banks anticipated, with implications for their forward guidance policies.

The Bank of England and the Federal Reserve were both recently forced to upend forward guidance tied to unemployment rates, after it became clear their ‘thresholds' for considering rate hikes would be reached sooner than initially thought. Critics are painting such misjudgements as failures – something the banks' themselves vehemently deny, arguing instead that it shows guidance has been successful in boosting economic growth.

Jinny Yan, a London-based economist with Standard Chartered, said revisions in the past year have been "huge", but added that forecasting is a "tough job" and that few others – including her own employer – have better track records. The Riksbank report concurs, arguing that the "constant changes in the economy" are "difficult or impossible to predict", meaning that even well-founded forecasts "must be revised along the way".

"If we say central banks have made the wrong decisions on the back of [erroneous forecasts], then yes, they should be harshly judged," said Yan, but added that "under the circumstances, they have done alright".

She added that "you always have to take a view on the market" and that once there is a starting point, it can be revised "accordingly". "Making the wrong forecasts is not critical," Yan argued. "The important thing is that they address it [later on]".

But Yan also highlighted the risk that central banks are undermining their hard-earned credibility by missing targets and switching policies, noting they are very careful to use words like "phase" instead of "change".