Forward Guidance

4 Key excerpts on "Forward Guidance"

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  eBook - ePub

  Designing Central Banks

  • Heinz Herrmann, David Mayes, Geoffrey E Wood(Authors)
  • 2009(Publication Date)
  • Routledge

    (Publisher)

  6 Forward Guidance for monetary policy

  Is it desirable?*

  Hans Gersbach and Volker Hahn

  There is substantial disagreement among both policy makers and academics about the merits of Forward Guidance for monetary policy. Consequently, practice regarding Forward Guidance varies significantly across central banks and over time. Many central banks divulge nothing about the future actions they are likely to take. As documented by Geerats et al. (2008), the ECB currently uses a traffic-light system with different code words in order to signal its likely decisions in the near future. The Federal Reserve has experimented with different practices. In May 1999 it started publishing a policy bias or policy tilt, but this was discontinued after one year.1 In 2003 the Fed embarked on a new attempt to issue Forward Guidance. The central banks of Iceland, New Zealand, Norway and Sweden are much more explicit and publish numerical values for the future path of interest rates.

  In this chapter we summarise the arguments for and against the desirability of Forward Guidance put forward in the literature and assess their validity in the context of various frameworks. We focus on Forward Guidance through interest-rate projections. Forward Guidance can serve two purposes, representing either a commitment device or a means of communication. We point out that there are limits to the communication of private information through Forward Guidance. If Forward Guidance represents cheap talk, the precision of the information transmitted by the central bank is limited by credibility problems. If Forward Guidance is used as a commitment device, a trade off arises between gains from commitment and losses in flexibility.

  The chapter is organised as follows: in the next two sections we summarise the main arguments in favour of and against Forward Guidance. We provide an assessment of these arguments for different scenarios in Section 3 . Section 4

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  The Global Financial Crisis in Retrospect

  Evolution, Resolution, and Lessons for Prevention

  • Anthony Elson(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Another innovation was the policy of “Forward Guidance”, which was initiated in the Fed’s FOMC meeting in December 2008 with a view to communicating to the markets the FOMC’s expectations for economic activity and the likely course of its short-term policy rate. Forward guid- ance had been used in previous FOMC statements, but on an irregular basis. For a number of years prior to the global financial crisis, statements had been issued following each FOMC meeting that contained a brief one- or two-paragraph view of the current economic situation and outlook along with a signal of the concerns or conditions that would guide policy rate adjustments in the future. Beginning in December 2008, with the zero lower bound in effect, the committee began to make more explicit its expectations for the future path of its policy rate. 23 A. ELSON 91 Forward Guidance was expected to influence future interest rates in a manner similar to actual adjustments of the federal funds rate. The primary purpose of Forward Guidance was to influence financial market expecta- tions of the future path of short-term interest rates that would, in turn, influence long-term interest rates, especially if the guidance provided by the FOMC was different from financial market forecasts. As noted earlier, changes in long-term rates would affect those pertaining to auto loans and mortgages for consumers, as well as business purchases of plant and equip- ment. More specifically, Forward Guidance can affect both components of long-term interest rates: first, the component that reflects the expected future path of short-term interest rates and second, the term premium related to the extra risk of holding a long-term financial instrument in a world of interest rate uncertainty. If the Fed’s guidance suggests that an accommodative stance will last longer than expected by the public, then both components of long-term interest may fall.

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  The Changing Fortunes of Central Banking

  • Philipp Hartmann, Haizhou Huang, Dirk Schoenmaker(Authors)
  • 2018(Publication Date)
  • Cambridge University Press

    (Publisher)

  So almost all forms of Forward Guidance used have been conditioned on economic develop- ments following their expected path and have envisioned inflation returning to its target value once the special circumstances have 69 Central Bank Talk about Future Monetary Policy passed. Still, as discussed below, the Federal Reserve’s forward gui- dance has embodied other forms of commitment – at a minimum to a different reaction function than had been followed in the past, and often to the passage of time, though this last commitment has usually been qualified. 5.1.3 Challenges for Forward Guidance Monetary policymaking is a complex, subtle undertaking. It should be focused on attaining its objectives as expeditiously as possible con- sistent with macroeconomic stability. It needs to use all available information about likely progress towards its objectives, and that information should be interpreted through some sense of the underly- ing structure of the economy and relationships among key variables that is explained to the public. Policy explanations should include dis- cussions of equilibrium values as well as of the forces pushing the economy towards those equilibriums or holding it back. But, critically, all that is subject to revision as new information arrives in an uncertain world, and any explanations or expectations must take account of that uncertainty. New information will give insight on the evolving state of the economy and also on the end points – where it might be evolving to. The past eight years have been marked by a considerable degree of uncertainty in several dimensions. Among them are how the interplay of financial factors, including debt-burdened balance sheets and impaired lenders, would affect the recovery from a very deep recession and how markets, households and businesses would respond to unprecedented monetary policy actions.

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  Economic Forecasting and Policy

  • N. Carnot, V. Koen, B. Tissot(Authors)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  1 In this Chapter and the next, the term ‘forecast’ will be used throughout even when ‘projection’ might be more appropriate (on the difference between the two, see Chapter 1). Policy Making and Forecasts 311 conduct of economic policy, particularly fiscal and monetary policy (section 8.2) and to the role forecasts play in other forums (section 8.3). The focus then shifts to communication issues. First, some of the technical subtleties are dif- ficult to explain in a simple way, not least with regard to the uncertainties sur- rounding the forecast (section 8.4). Second, there is the question of how much transparency is desirable: to what extent should governments and central banks publish their forecasts or keep them confidential (section 8.5)? Third, in the case of official forecasts, it is important to acknowledge their ambivalent status: they are both a technical and a political exercise, and this raises tensions that need to be addressed (section 8.6). Complementing the chapter is a world tour of forecasting institutions in Appendix 8.1. 8.1 Economic forecasts’ virtues and limitations 8.1.1 The value added by forecasts The rationale for economic forecasts stems from four basic facts: the existence of lags; the complexity of economic links; the irreversibility of many decisions; and uncertainty. First, forecasts help to assess the full impact of decisions taken in the present, which materialize with a lag. For example, when a central bank cuts or raises its policy rate, it expects inflation to be affected with a lag, with the bulk of the impact coming one to two years down the road. Even inaction is a decision, and warrants evaluating what the implications are when going forward. And forecasts are a way to reduce, or at least to better circumscribe, the uncertainties surrounding the future. Second, economies are complex systems, with many interactions.

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