zdenek tuma : the forecasting process from the perspective of a new eu member speech by mr zdenek tuma, governor of the czech national bank, at the bundesbank's eighth spring conference - new developments in economic forecasting, eltville, 5 may 2006. * * * ladies and gentlemen, dear colleagues, it is my pleasure to be here tonight to share with you some thoughts on the forecasting process at central banks, and in particular at the czech national bank as an example of a new eu member state. it is generally recognised that central bank policies must be forward - looking. as emphasised by milton friedman, for example, there are long lags between monetary policy actions and their impact on the economy. this means that policies responding only to the current state of the economy might miss turning points and be pro - cyclical rather than stabilising. therefore, central banks have always been among the leaders in the macroeconomic forecasting field. david hendry in his recent book on forecasting aptly remarks that whereas a failure in the stochastic part of the forecast is still something you can live with, a failure in forecasting the trend can cause enormous inaccuracy of the forecast. consequently, forecasting techniques do not necessarily have to match for any short - run movement ; however, they must not fail when break points in the economy are under consideration. well, you all well know that milton friedman was rather sceptical about our ability to avoid serious mistakes in this very area and that led him towards the formulation of a “ simple rule ” of constant growth of the money stock. in this framework no forecasting was required. of course, he faced evidence of the failure of the large - scale econometric models that had been used in the 1950s to 1970s and that were later subject to strong criticism. the models were hit by a series of structural breaks, which made the previously observed relationships unreliable. consequently, it was argued that these breaks were not a result of bad luck only, but also reflected a lack of microeconomic foundations in the models, neglect of forward - looking expectations and ad hoc econometric restrictions. the terms “ lucas critique ” and “ goodhart law ” have become standard warning signs for all macroeconomic modellers. the actual way in which forecasts are produced and used at central banks has, however, changed substantially over the past two decades. the changes have reflected developments both in the economic ( and eco

for policy decision - making. the entry of the czech republic into the european union in may 2004 has not so far created any serious issue in respect of the practical forecasting of the czech economy. however, we can identify two issues related to the future development of the forecasting system. the first one relates to the comparability of the cnb ’ s forecast with the rest of the forecasts produced by the escb members. as i mentioned earlier, the cnb produces an unconditional forecast that includes a reaction function of the central bank. however, this is not the case with the rest of the escb members. although there is a tendency towards the use of unconditional forecasts and the bank of england and sveriges riksbank have started to use at least the trajectory of the short - term interest rate derived from the money market term structure instead of an assumption of a constant short - term interest rate as a base for their forecasts, conditional forecasting still plays a crucial role among the escb members. this, of course, seriously reduces the comparability of the results. second, the forecasting system and the modelling framework have not yet been adjusted to our expected entry into the erm ii and the euro area. erm ii participation clearly raises the question of consistency between the “ low ” inflation environment required by the maastricht inflation criterion and stability of the nominal exchange rate, both in a converging economy. recent experience among the new eu member countries provides some evidence on the difficulties of fulfilling the maastricht inflation criterion amid a stable exchange rate. the issue to be solved is to what extent the forecasting system should reflect the dualism of the targets, or whether the policy rule should consider the inflation target only, leaving the exchange rate as a fully endogenous variable. similarly, the forecasting system will have to be adjusted once the czech republic enters the euro area and policy is set by the ecb governing council. it is worth mentioning that the development of our forecasting system has been part of the wider evolutionary process that the czech inflation targeting regime has gone through. the first years of the new regime were not easy, and included frequent numerical target misses. nevertheless, the czech republic enjoys low inflation, and inflation expectations seem to be firmly anchored at low levels at present. monetary policy decision - making is rule - based and transparent, thereby enhancing the credibility of the cnb. let me conclude with the statement that a