June 2009 issue contents
The Interest Rate Conditioning Assumption

 by Charles Goodhart
Financial Markets Group, London School of Economics


A central bank's forecast must contain some assumption about the future path for its own policy-determined short-term interest rate. I discuss the advantages and disadvantages of the three main alternatives:

  1. constant from the latest level
  2. as implicitly predicted from the yield curve
  3. chosen by the monetary policy committee (MPC)

Most countries initially chose alternative (i). With many central banks having planned to raise interest rates at a measured pace in the years 2004-06, there was a shift to (ii). However, Norway, and now Sweden, has followed New Zealand in adopting (iii), and the United Kingdom has also considered this move. So this is a lively issue.

JEL Codes: G21, G28.

Full article (PDF, 24 pages 294 kb)