Forward guidance: is it always effective?

Which forward guidance (FG) is effective?

Ehrmann and al. study the impact of different types of FG on the responsiveness of bond yields to macroeconomic news, and on forecaster disagreement about the future path of interest rates. They find that:

• Time-contingent FG over long horizons eliminates both the asset price response to incoming news and substantially reduces disagreement across forecasters;
• State-contingent FG works in the same direction, but preserves some responsiveness and disagreement, because future policy continues to depend on a subset of macroeconomic information;
• Calendar-based FG, i.e. time-contingent FG over short horizons, counterintuitively increases the news-sensitivity of bond yields and is ineffective in reducing forecaster disagreement; and
• Open-ended FG is largely ineffective.

Can more public information raise uncertainty? The international evidence on forward guidance
Authors: Michael Ehrmann, Gaetano Gaballo, Peter Hoffmann, Georg Strasser
From: ECB, Banque de France

An example of the counterintuitive effects of calendar-based FG

Stavrakeva and Tang studied how the US monetary policy during the Great Recession affected the dollar. Their conclusion:

Conventional wisdom holds that lowering a home country’s interest rate relative to another’s will depreciate the domestic currency. We document that US monetary policy easings actually had the opposite effect during the Great Recession. We attribute this effect to calendar-based forward guidance that signaled economic weakness which resulted in a flight-to-safety effect and lower expected inflation in the United States.

The Dollar During the Great Recession: US Monetary Policy Signaling and The Flight To Safety
Authors: Vania Stavrakeva, Jenny Tang
From: London Business School, Federal Reserve Bank of Boston