Monetary policy decision-making requires that two fundamental questions be answered: (1) How is the economy doing? and (2) Where is the economy headed? The need to assess the status of the economy both in the present and prospectively is due to the fact that the instruments of monetary policy act slowly on the economy. This is known as the transmission mechanism, through which changes in the benchmark interest rate affect other market interest rates with a variable lag that may take up to six quarters. The answer to each of these two questions involves a significant degree of uncertainty for the following reasons:
1. The information on most of the economic variables (for example, GDP, employment, international trade, etc.) is only available with a lag.
2. Other important variables (such as the output gap or potential growth of the economy, the natural unemployment rate, the real equilibrium exchange rate, etc.) are unobservable, and must therefore be estimated through indirect models and indicators.
3. In most cases, it is difficult to predict the origin, effects, persistence, and magnitude of the shocks faced by the economy. Some examples of shocks are:
On the other hand, the scope and effects of the monetary policy are not always predictable because they depend on:
What actions does the Central Bank of Colombia take to reduce uncertainty?
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