U.S. Federal Reserve officials dropped their promise to remain “patient” on March 18 as they considered when to begin raising rates. They’ll return to setting policy meeting-by-meeting, based purely on the economic data in front of them, ending an extraordinary era of communications that began in 2008. For more than six years they committed to keeping rates near zero, sometimes for specific chunks of the calendar, sometimes until certain thresholds for unemployment and inflation were met, and sometimes for bafflingly hazy periods, such as the “considerable time” that appeared in March 2014. By contrast, the European Central Bank has stuck with vague language all along. Central bank watchers around the globe have also latched on to new economic forecasts and inflation targets provided as part of the forward guidance push, some of which are sowing confusion. The shifts have triggered bouts of volatility in global markets, reminding some critics of the blessings of bewilderment. Conflicting statements from Bank of England Governor Mark Carney in June 2014 prompted one lawmaker to say he was acting like an “unreliable boyfriend” – “one day hot, one day cold.”
"If I seem unduly clear to you, you must have misunderstood what I said." --Alan Greenspan, 1987
Cutting interest rates wasn’t enough to spark an economic recovery after the 2008 crisis, so central bankers looked for new tools. To encourage investment and spending, they set out to broadcast — in various ways — that they would keep rates low for a long time. It was a dramatic shift from the way central bankers used to talk. Former Fed Chairman Alan Greenspan, renowned for impenetrability, didn’t agree to release statements after rate-setting meetings until 1994, and then only under pressure to be more forthcoming. The Fed statements have gotten longer and more detailed over the last two decades, and parsing the pronouncements of central bankers the world over remains a big industry. In the late 1990s, a small number of countries, including New Zealand, Norway and Sweden, began setting inflation targets and forecasting the path of interest rates. The Bank of Japan was the first to use forward guidance to signal that rates would remain low after pushing them to zero in 1999 to stave off deflation. The Fed and other central banks also used asset purchases, known as quantitative easing, to create new money to fuel the recovery, giving them a new set of moves to explain and forecast — and stumble over.
"We will continue to try to communicate as clearly as we possibly can." -- Janet Yellen, 2014
Central bankers argue that forward guidance worked. Rock-bottom short-term rates, accompanied by assurances they would stay there, translated into lower long-term rates, bringing down the cost of corporate borrowing and mortgages. Banks and companies had more confidence to lend and invest once they knew what conditions would cause central banks to tap the brakes. Critics say the approach offered mixed messages and created confusion. The best example of bungled communications came in 2013 when then-chairman Ben S. Bernanke said the Fed might slow bond buying in the next few meetings, igniting a plunge in global stocks and a record surge in Treasury yields in an event that became known as the “taper tantrum.” Some economists say central bankers should either return to the silent treatment or provide outright rate forecasts, as muddling between the two extremes creates too much risk of being misunderstood.
The Reference Shelf
- A March 2014 report from the Bank of International Settlements on the impact of forward guidance when interest rates are near zero.
- Centre for Economic Policy Research collection on inflation targeting and central bank strategies after the crisis.
- The Bank of England’s statements on forward guidance from August 2013 and February 2014.
- A 2012 study from the Federal Reserve Bank of Chicago on the impact and risks of forward guidance.
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