Forward Guidance at the Effective Lower Bound: International Experience

Forward guidance is one of the policy tools that a central bank can implement if it seeks to provide additional monetary stimulus when it is operating at the effective lower bound (ELB) on interest rates. It became more widely used during and after the global financial crisis. This paper reviews the international experience, based on the six central banks that have used forward guidance when operating at the ELB, in order to assess its effectiveness and the potential risks associated with its implementation. We distinguish between three distinct types of forward guidance (qualitative, time contingent and state contingent) and discuss the channels through which forward guidance operates. Overall, we find that forward guidance can be an effective tool at the ELB when clearly communicated and perceived as credible. Though evidence from the literature is somewhat mixed—since the specific effects vary across economies, episodes and type of guidance—it has generally been found to be effective in (1) lowering expectations of the future path of policy rates, (2) improving the predictability of short-term yields over the near term and (3) changing the sensitivity of financial variables to economic news. However, as with other monetary policy tools, the benefits of forward guidance need to be weighed against the costs. Those costs are mainly associated with potential loss of credibility and increased financial stability risks. Moreover, the international experience with forward guidance under conditions of negative ELBs and interest rates is limited to date.