Publishing the interest rate forecast may not be sufficient to communicate the central bank’s reaction function, as one specific forecast does not in itself convey much information about how the central bank responds to various shocks. One could argue that three ingredients are required; 1) the forecasts, 2) how the central bank responds to shocks, and 3) the criteria underlying the forecasts and reaction function. The first two ingredients provide efficiency in monetary policy, in the sense that private agents knowing the central bank’s assessments and reaction function can respond appropriately to economic developments. The third ingredient contributes to a better understanding of the objectives of monetary policy and the link between objectives and policy. This could underpin the credibility of the reaction pattern, and is also important for democratic accountability. In addition, the reaction function could change over time, for example due to a change in how the economy works or an improvement of the understanding of economic mechanisms. The criteria could then give some guidance to the public on how and why the reaction function might change. Let me briefly explain how Norges Bank communicates the three ingredients of our communication, and let me start with the forecasts. Chart 1 shows the forecasts of the key variables. The uncertainty bands are based on model simulations and reflect estimated variances of the different shocks. (Note that there is also a fan chart for historical values of the output gap, since there is also uncertainty about potential output in retrospect.)

The interest rate set by central banks is normally a very short-term interest rate, which in itself has negligible effects on economic decisions. It is mainly expectations about future policy rates that affect market interest rates and thus economic decisions. Most central banks communicate future policy intentions in one way or another. The majority of central banks communicate indirectly through forecasts based on technical interest rate assumptions, and by giving verbal signals about future interest rate decisions in policy statements and speeches. With such indirect communication, the market participants gain information about the sign of future interest rate decisions, but may have less information about the size. Until November 2005, Norges Bank used technical interest rate assumptions in the inflation forecasts, but also on some occasions commented on whether the Bank intended to follow a different policy than what seemed to be reflected in market interest rates. Thus, the Bank gave signals about the sign of future policy intentions relative to market expectations, but not on the size. 3 From November 2005, Norges Bank started to use endogenous interest rate forecasts in the Monetary Policy Report. Norges Bank was the  1  This process has also been acknowledged by the Norwegian parliament: “The majority think that it is a prerequisite for an effective monetary policy that the central bank is open about the interest rate forecasts, and are satisfied with the fact that Norges Bank emphasises this.” (Innstilling frå finanskomiteen om Kredittmeldinga 2007, Innst.S.nr.274, s.11.