Forward guidance is the provision of information by central banks about the future conduct of monetary policy and in particular about the central bank's policy interest rate. Forward guidance is aimed at influencing the public's expectations. This goal is not new. It has long been understood that managing expectations is an important part of monetary policy. In fact, following the high inflationary 1970s, institutions were put in place to credibly anchor expected inflation rates to a low target level.1 The economic logic for this sort of expectations management is simple. Prices and wages set today depend crucially on people’s expectations of the future paths of prices and wages. For example, current inflation will be lower when expected future inflation is lower.
Forward guidance shares the basic economic logic that links today’s decisions to future expectations, but it differs in its subject. Forward guidance focuses on the instruments of monetary policy rather than the targets of monetary policy.
But this aspect of monetary policy is also not new. Before the Global Crisis, monetary-policy committees provided information about their policy interest rate in future periods as well as setting the current rate. Some did so explicitly – providing a numerical forecast of the forward path of the policy interest rate. Other monetary-policy setters did it implicitly – providing more or less explicit messages in official statements and speeches.
What is new, is the scope and motivation for using forward guidance as a monetary-policy tool.2 This has changed substantially during the recent economic downturn for several central banks. The aims of this eBook are to:
- Highlight how the implementation of forward guidance has evolved over time;
- Clarify what central banks hope to achieve with forward guidance;
- Discuss what economic theory says about forward guidance; and
- Raise possible objections to forward guidance or to the way it is currently implemented.
To accomplish these goals, this eBook brings together a collection of contributions written by a diverse group of authors. This include
- Central-bank officials from the Bank of England, the Bank of Japan, the ECB, and the US Federal Reserve;
- Researchers at universities and central banks; and
- Financial-market practitioners.
Here is the full list of contributions and contributors:
Central Bankers on Forward Guidance: Description and Motivation
1. "Forward Guidance and the ECB" by Peter Praet
2. "Forward Guidance in the UK" by Spencer Dale and James Talbot.
3. "Forward Policy Guidance at the Federal Reserve" by John Williams
4. "Bank of Japan's Current Monetary Easing and Forward Guidance" by Sayuri Shirai
5. "Monetary Policy and Forward Guidance in the UK" by David Miles.
Empirics and Economic Theory on Forward Guidance
6. "Low for how Long? Estimating the ECB's Extended Period of Time" by Tilman Bletzinger and Volker Wieland.
7. "Odyssian Forward Guidance in Monetary Policy: A Primer" by Jeffrey Campbell.
8. "The Macroeconomic Effects of Forward Guidance" by Marco Del Negro, Marc Giannoni, and Christina Patterson.
9. "The Value of Forward-Looking Communication" by Francesco Bianchi and Leonardo Melosi.
Improving the implementation of forward guidance
10. "Complete Forward Guidance" by Richard Barwell and Jagjit Chadha.
11. "Effective Forward Guidance: Scrupulous Central Bankers and Forecast Contracts".
12. "Forward Guidance in the UK: Holding Rates Down till Something Happens" by David Cobham.
13. "Forward Rate Guidance" by Charles Goodhart.
14. "Forward Guidance: A Central Bank Watcher's Perspective" by Paul Sheard.
15. "A Long and Bumpy Journey ahead for Forward Guidance" by Kazuo Ueda.
This eBook is intended as part of an ongoing effort to understand and refine forward guidance. The recovery of the Canadian economy following the adoption of forward guidance by the Bank of Canada mid 2009 raised hopes that forward guidance is a powerful tool to kick-start the economy. It is too early to tell, however, whether forward guidance is effective in stimulating growth and if so what type of forward guidance is best. Nevertheless, the contributions in this eBook highlight several key lessons about forward guidance and its role for monetary policy. Those are the following.
- A recurrent problem facing central banks throughout this crisis is that the public expects a loosening of monetary policy to take place earlier than monetary policymakers. Although forward guidance has been shown to affect markets' expectations to some extent, not a single implementation of forward guidance has managed to closely align market expectations with policymakers' intentions. At least not yet.
- Forward guidance aimed at stimulating growth creates a tension between this short-term objective and the central bank's objective of low and stable inflation rates. Through statements and speeches, policymakers emphasise that their inflation objectives are still in place, but this could reduce the effectiveness of forward guidance in lifting a struggling economy to sustained growth.
- Economic theory predicts that a forward guidance policy that commits to keeping the policy rate 'lower for longer' than what is prescribed by the normal central bank's policy can generate substantial growth. Several policymakers – although not all – explicitly argue that this element is not part of their forward guidance policy. Without such a 'lower for longer' element, it is more difficult to see how forward guidance can stimulate growth, except when forward guidance reduces market expectations about the forward path of policy interest rates, which in turn would put downward pressure on long-term rates (as mentioned in the first bullet point).
- Communication of monetary policy is never easy. This is especially true for new policies like forward guidance. Even when policymakers carefully craft forward guidance policies with escape clauses and guarantees about inflation targets, there is no guarantee that the nuance is missed by the public. Consequently, a policy that is not meant to be a 'lower for longer' policy can still be interpreted by the market as a 'lower for longer' policy. If this leads to additional borrowing with interest payment obligations that will become problematic when interest do rise, then central bank's credibility may be negatively affected.
- Forward guidance may be beneficial even if it doesn't fundamentally affect anything. Forward guidance may signal to the world that central banks will leave no stone unturned and it is this continued search for solutions and central bankers' perseverance that will prevent our hopes from collapsing and will prevent the economy from becoming stuck in the kind of self-fulfilling trap of low growth that David Miles describes in his contribution to this eBook.
The best time for forward guidance may lie in the future. Central banks' balance sheets have ballooned and there is a lot of uncertainty about the question when and at what pace these balances are going to be unwinded. The recent sharp market reactions to announcements by the FOMC on when to start tapering off asset sales have made clear that this process is not without risks. Providing guidance on how central banks will proceed in doing so may be crucial in completing this process without severe disruptions. Barwell and Chadha argue in their contribution to this eBook that central banks should already provide guidance on what monetary policies will look like after takeoff of the policy interest rate from the effective lower bound. The Federal Reserve already does this four times a year. Last month, it reported individual forecasts of FOMC participants for the target federal funds rate for 2014, 2015, 2016, and the 'longer run'. As the day of takeoff comes closer (and hopefully this will be sooner than later), then providing information on the path towards normalised monetary policy could become very useful and central banks will have to consider seriously if – and if so how – they would do this.
Woodford, Michael (2012), "Methods of Policy Accommodation at the Interest-Rate Lower Bound", manuscript, Columbia University.
1 See Paul Sheard's contribution in this eBook.
2 See Woodford (2012) for an excellent detailed overview.