How is the forecast drawn up?

The key document underlying interest rate decisions is the macroeconomic forecast, as the Bank Board sets interest rates based on expected inflation, not current inflation. The forecast for inflation at the “monetary policy horizon” (about 12–18 months ahead) is of greatest relevance to monetary policy decision-making.

The forecast is drawn up four times a year by the Monetary Department. It takes a large team of economists about a month to prepare each forecast. At their initial meetings, they discuss the initial state of the forecast, in particular the current position of the domestic economy in the business cycle. The settings of the initial state largely determine the message of the forecast. For this reason, the Bank Board is also involved in this discussion. Expected developments abroad are another important assumption of the forecast. The forecast for the external environment is based on the CNB’s own forecasting models and on market outlooks and forecasts made by foreign analysts.

Before the initial state is set, a short-term forecast is drawn up on the basis of an analysis of new data using special models and expert judgement. The short-term forecast for the next quarter is then entered into the core projection model, which is made up of dozens of equations. The equations describe the key relationships in the Czech economy and between the Czech economy and the rest of the world over the medium term. The forecast generated by the core projection model is again subject to expert debate among economists in the Monetary Department and to other potential expert adjustments. The process of integration of the model-based and expert views of future economic developments is the most demanding and time-consuming part of the forecasting process. At the end of this process we obtain the final version of the baseline scenario of the CNB’s macroeconomic forecast.

The baseline scenario of the forecast is the most likely future path of the Czech economy as seen by the Monetary Department’s economists. One particular interest rate path leading future inflation to stay close to the 2% inflation target is consistent with the baseline scenario. However, this trajectory cannot be viewed as unconditionally binding as regards the actual future path of interest rates. Incoming new information and different views of Bank Board members of economic developments than those outlined in the forecast may cause the actual interest rate path to deviate from the forecasted path. Besides the baseline scenario – the emerging contours of which the Bank Board is kept informed about – the Monetary Department draws up additional scenarios based, among other things, on this communication with the board. They capture the main risks and uncertainties of the forecast, offering an alternative view of possible future developments. The baseline and additional scenarios are then presented to the Bank Board at the monetary policy meeting and subsequently published in the Monetary Policy Report.