Theoretical considerations and practical experiences of forward guidance

The communication of monetary policy has changed substantially in recent decades as central bank transparency has become ever more widespread. This increase in central bank transparency arose from the need for the accountability of the newly independent institutions and also from the recognition that, in addition to policy instrument changes, monetary policy can also influence economic developments by shaping expectations. In the financial crisis of recent years, several central banks’ base rates have approached the zero lower bound, which intensified the importance of forward-looking communication, as the shaping of expectations has remained the only instrument for conventional monetary policy to use in its effort to implement the additional easing necessitated by the state of the economy. Another approach, less widespread in the international literature as of yet, holds that the expected real interest rate cannot be lowered and current expenditure thus stimulated by raising inflation expectations; forward guidance can, however, keep long-term nominal yields low and prevent real interest rates from rising and bond markets from reacting excessively through normalisation. We take a look at the practice of, and experiences from, forward guidance during the crisis through the example of the Federal Reserve (Fed) and the European Central Bank (ECB). Based on our findings, although the strategic importance of this type of communication instrument may wane after the crisis, there has been an undeniable shift towards communicating monetary policy assessments of, and responses to, the prevailing conditions, and thus towards a greater transparency in the operation of central banks.