When was forward guidance introduced

Forward guidance is a tool used by a central bank to exercise its power in monetary policy in order to influence, with their own forecasts, market expectations of future levels of interest rates.

Communication about the likely future course of monetary policy is known as "forward guidance". Individuals and businesses will use this information in making decisions about spending and investments. Thus, forward guidance about future policy can influence financial and economic conditions today.[1]

The strategy can be implemented in an explicit way, expressed through communication of forecasts and future intentions, sometimes known as Odyssean forward guidance.[2] Implied forward guidance also exists, sometimes referred to as Delphic forward guidance. It is a softer and less-binding version of forward guidance to achieve similar effects. Among the main central banks, Delphic forward guidance dominates, although there are a couple of exceptions such as the US Federal Reserve, which makes quite specific but still conditional statements, and the Bank of Japan.[3]

History

The communication policy of the Federal Reserve Bank of the United States has evolved over time. The current policy is known as "forward guidance" but this is quite recent. In fact, starting in 1994 the decisions of scheduled meetings have been announced to the public within a few minutes of 2:15 pm Eastern Time. Prior to 1994 monetary policy decisions were not announced, and investors had to indirectly infer policy actions through the size and type of open market operations in the days following each meeting.[4] In the current context, this could be called "reverse guidance". The policy of "forward guidance" came about in the early 2000s.[1] This has apparently resulted in a market-timing strategy, in use since 1994, "where the S&P500 index has on average increased 49 basis points in the 24 hours before scheduled FOMC announcements. These returns do not revert in subsequent trading days and are orders of magnitude larger than those outside the 24-hour pre-FOMC window. As a result, about 80% of annual realized excess stock returns since 1994 are accounted for by the pre-FOMC announcement drift". In fact, about half of the realized excess stock market returns between January 1980 and March 2011 were earned during the "pre-FOMC" window whereas there is no evidence of pre-FOMC returns before 1980.[4] The drift is generally not dependent on either the macro economic state, market trends or action taken by the FOMC[5]

References

1. ^ a b "The Fed - FAQs".
2. ^ Jeffrey R. Campbell; Charles Evans; Jonas D. M. Fisher; Alejandro Justiniano. "Macroeconomic Effects of Federal Reserve Forward Guidance". ideas.repec.org.
3. ^ "BoE's Carney unleashes Delphic forward guidance? @Euromoney". Euromoney.
4. ^ a b David O. Lucca; Emanuel Moench (September 2011). "The Pre-FOMC Announcement Drift" (PDF). Federal Reserve Bank of New York Staff Reports, no. 512.
   
   This article incorporates text from this source, which is in the public domain.
5. ^ L Nilsson (August 2015). "The Curious Case of the Pre-FOMC Drift". SSRN 2640477. {{cite journal}}: Cite journal requires |journal= (help)

See also

• Window guidance

Retrieved from "https://en.wikipedia.org/w/index.php?title=Forward_guidance&oldid=1087099857"

Forward guidance refers to the communication from a central bank about the state of the economy and the likely future course of monetary policy. It is the verbal assurance from a country's central bank to the public about its intended monetary policy.

• Forward guidance refers to the communication from a central bank about the state of the economy and the likely future course of monetary policy.
• Forward guidance attempts to influence the financial decisions of households, businesses, and investors by providing a guidepost for the expected path of interest rates.
• Forward guidance attempts to prevent surprises that might disrupt the markets and cause significant fluctuations in asset prices.

Forward guidance attempts to influence the financial decisions of households, businesses, and investors by providing a guidepost for the expected path of interest rates. The central bank's clear messages to the public are one tool for preventing surprises that might disrupt the markets and cause significant fluctuations in asset prices.

Forward guidance is a key tool of the Federal Reserve (Fed) in the United States. Other central banks, such as the Bank of England (BOE), the European Central Bank (ECB), and the Bank of Japan (BOJ), use it as well.

Almost all recent Fed chairs, including Ben Bernanke, Janet Yellen, and now Jerome Powell, have been strong proponents of forward guidance. However, before the long tenure of Alan Greenspan, the Fed was far more reticent about telegraphing its intentions into the market.

Forward guidance consists of telling the public not only what the central bank intends to do but what conditions will cause it to stay the course and what conditions will cause it to change its approach.

For example, in early 2014, the Fed's Federal Open Market Committee (FOMC) said it would continue to keep the federal funds rate at the lower bound at least until the unemployment rate fell to 6.5% and inflation increased to 2% annually. It also said that reaching these conditions would not automatically lead to an adjustment in Fed policy.

With some sense of where the economy might be headed, individuals, businesses, and investors can have greater confidence in their spending and investing decisions. Also, forward guidance can help the financial markets function more smoothly. For example, if the FOMC indicates it expects to raise the federal funds rate in six months, potential home buyers might want to get mortgages ahead of a potential increase in mortgage rates.

During the FOMC meeting on March 15-16, 2022, the Fed increased interest rates in an effort to combat rising inflation. The Fed's target range was increased by .25% (or 25 basis points), for the first time since 2018—going from 0% to .25% to .25% to .50%.

In the U.S., the Fed's FOMC has used forward guidance as one of its major tools since the Great Recession.

Through the use of forward guidance, the FOMC has communicated its intent to keep interest rates low for as long as needed to improve credit availability and stimulate the economy. Similarly, Fed Chair Jerome Powell communicated to the financial markets that the Fed would continue to support the U.S. economy until the effects of the global financial crisis have subsided.