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How Central Banks Use Inflation Forecast Targeting
Description
In this episode of Monetary Policy Explained with Fexingo, Lucas and Luna break down inflation forecast targeting—the central bank strategy of using economic models and data to set interest rates based on where inflation is expected to be two years out. They walk through how the Reserve Bank of New Zealand pioneered this approach in 1990, and how the Bank of England adopted it in 1992. Lucas explains the mechanics: central banks publish quarterly inflation projections, and if the forecast is above target, they raise rates preemptively. Luna challenges the reliability of these models, noting that post-pandemic supply shocks threw off projections globally. The hosts discuss the trade-off between credibility and flexibility, and whether forecast targeting survives in a world of more frequent shocks. A concrete look at how central banks try to see around corners, with real examples from New Zealand and the UK.