After the financial crisis, with interest rates stuck at zero, central banks tried to gee up economies with a variety of new measures. One was forward guidance: pledging to keep policy loose for a while. In 2011 the Federal Reserve said it expected rates to remain low until mid-2013; this was then pushed back to mid-2014, then mid-2015. Forward guidance is now an established part of the monetary policy toolkit. But what is the best way to deploy it once interest rates are rising? A new paper, presented last week at Chicago Booth’s Monetary Policy Forum in New York, argues that in normal times, not all central bank promises are equal.
There are two types of forward guidance. One uses a timeframe. The Fed did this most recently in October when, in its post-meeting statement, it referred explicitly to the importance of the next meeting (in December, when it raised rates). The alternative is not to mention dates, but say how, in general, interest rates would respond to different turns of events. For example, in 2014 the Bank of England promised—with some caveats—not to raise rates until unemployment fell below 7%.
Michael Feroli,...Continue reading
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