“Mensch tracht, und Gott lacht” – what’s the best guidance on monetary policy?
David Miles22 October 2014
Many central banks embrace forward guidance by announcing expected interest rate paths. But how likely it is that actual rates will be close to expected ones? This column argues that quantifying such uncertainty poses great difficulties. Precise probability statements in a world of uncertainty (not just risk) can be misleading. It might be better to rely on qualitative guidance such as: “Interest rate rises will probably be gradual and likely to be to a level below the old normal”.
“Mensch tracht, und Gott lacht” is a Yiddish proverb – men plan and God laughs. Woody Allen puts the same thought this way: “If you want to make God laugh tell him about your plans”. Some people might see these words as a fitting epitaph for forward guidance on monetary policy. The Bank of England has certainly faced a good deal of criticism for the guidance that it has recently been giving, as has the Federal Reserve in the US.
What does the Fed’s language about 2013 mean? A rules-based interpretation
Olivier Coibion, Yuriy Gorodnichenko21 October 2011
The August 2011 meeting of the Federal Reserve's Federal Open Market Committee produced new language describing the expected path of interest rates over a two-year horizon. That language spurred a variety of interpretations, as some saw it as describing what was already expected and others interpreted it as a significant policy shift. This column examines the expected path of future interest rates and says that the new language was wholly consistent with past Fed practice.
In August 2011, members of the Federal Reserve’s Federal Open Market Committee (FOMC) reaffirmed their policy stance of maintaining the federal funds rate in a narrow range slightly above zero. But in an unprecedented step, they also added new language to their public release asserting that their current expectations of macroeconomic conditions would warrant “exceptionally low levels for the federal funds rate at least through mid-2013.” This new policy statement led to an unusual split of the committee – three (out of ten) voting members dissented.
Recent history of long-run inflation expectations suggests reasonably well-anchored expectations in both regions, however no studies to date have compared the recent evolution and dispersion across forecasters' long-horizon projections in the United States to those in the EU. The authors of CEPR DP6536 use daily evidence from financial markets and surveys, which reveal a substantially greater degree of forecaster disagreement about long-run inflation outcomes in the United States than in the euro area.
The United States and the euro area are economies of comparable size and openness; furthermore both the Federal Reserve and the European Central Bank (ECB) have a legal mandate to maintain price stability. Recent history of long-run inflation expectations suggests reasonably well-anchored expectations in both regions, however no studies to date have compared the recent evolution and dispersion across forecasters' long-horizon projections in the United States to those in the EU.
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