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An Assessment of Bank of England and National Institute Inflation Forecast Uncertainties

Published online by Cambridge University Press:  26 March 2020

Kenneth F. Wallis
Kenneth F. Wallis*
Affiliation:
Department of Economics, University of Warwick, CoventryCV4 7AL
*
e-mail: K.F.Wallis@warwick.ac.uk
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Extract

In February 1996 the Bank of England and the National Institute of Economic and Social Research significantly increased the amount of information they published about the uncertainty surrounding their central projections of inflation. In effect, and in different ways, they each began to publish a density forecast of inflation, that is, an estimate of the probability distribution of possible outcomes for future inflation. The Bank represented this graphically, as a set of forecast intervals covering 10, 20, 30, …, 90 per cent of the probability distribution, coloured red, of lighter shades for the outer bands. This was done for inflation forecasts up to eight quarters ahead, and since the distribution becomes increasingly dispersed and the intervals ‘fan out’ as the forecast horizon increases, the chart became known as the ‘fan chart’ (or, rather more informally, and noting its red colour, the ‘rivers of blood’). The National Institute represented the distribution as a histogram, in the form of a table reporting the probabilities of inflation falling in various ranges. These intervals, or ‘bins’ of the histogram, have changed from time to time; those used currently are: less than 1.5 per cent, 1.5 to 2.0 per cent, 2.0 to 2.5 per cent, and so on. The forecasts refer to the fourth quarters of the current and following years, and from the beginning have included not only inflation but also real GDP growth. Fan charts for real GDP growth first appeared in the Bank's Inflation Report in November 1997.

Type
Articles
Information
National Institute Economic Review , Volume 189 , July 2004 , pp. 64 - 71
Copyright
Copyright © 2004 National Institute of Economic and Social Research

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Footnotes

This article evaluates the density forecasts of inflation published by the Bank of England and the National Institute of Economic and Social Research. It extends the analysis of the Bank of England's fan charts in an earlier article by considering data up to 2003, quarter 4, and by correcting some technical details in the light of information published on the Bank's website in Summer 2003. National Institute forecasts are also considered, although there are fewer comparable observations. Both groups' central point forecasts are found to be unbiased, but their density forecasts substantially overstated forecast uncertainty.

∗

The comments and assistance of Michael Clements and Tim Taylor are gratefully acknowledged.

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