Do Central Bank Forecast Errors Contribute to the Missing of Inflation Targets? The Case of the Czech Republic

This paper is primarily concerned with assessing the bias of the CNB’s predictions in relation to undershooting of the inflation target. We conclude that the inflation prediction error has decreased over time. We further point out that GDP growth and interest rates were, respectively, above and below the forecast most of the time, even in a situation of systematic undershooting of the target. Thus, the undershooting cannot be explained with the help of standard demand mechanisms. Positive supply impulses were admittedly underestimated in the past. According to our findings, about half of the apparent target undershooting in 2003 was due to errors in the predictions of exogenous factors (foreign interest rates, GDP, and inflation). As follows from the distribution of the inflation prediction errors across separate price segments, overpredictions of inflation during most of the period under review were due to mistakes in the prediction of food prices and core CPI ex food, while prediction errors in energy prices mostly fostered convergence to the target. The prediction errors in regulated prices acted in both directions.