When central bankers speak, everybody listens. Not everybody, however, understands. For a long time, the central bankers liked it that way. They seemed to recite high-toned gibberish on purpose: Say too much too clearly, the thinking went, and they could give away the secrets to their god-like power to make economies rise or fall. Then the global financial crisis ushered in a new consensus that straight talk is better, that giving investors useful guidance to steer expectations for interest rates — already near zero — would help them navigate the worst recession in a generation. All of the world’s big central banks adopted the new communications strategy, known as forward guidance. Sometimes it backfired. Now they’re talking about how to overhaul their approach.
The U.S. Federal Reserve and the Bank of England were forced to revamp their forward guidance after abandoning a pledge to raise interest rates when unemployment dropped to a certain level. There were reasons for the switch — the jobless rate fell faster than expected but the recovery still wasn’t considered strong — but critics argued that the strategy was discredited and should be scrapped. The Fed had unveiled a 6.5 percent unemployment target after assurances about its time horizon for raising rates didn’t generate the market response it was hoping for. The European Central Bank has stuck with more vague language, saying only that rates would remain low for “an extended period of time.” The Fed and the Bank of England now say they are now looking at a broad range of metrics on jobs, consumer prices and financial markets. Central bank watchers are latching on to a new set of detailed forecasts and inflation targets provided as part of the forward guidance push, some of which are sowing confusion. Conflicting statements from Bank of England Governor Mark Carney in June on the likely timing of interest rate increases prompted one lawmaker to say he was acting like an “unreliable boyfriend.” The shifts have triggered bouts of volatility in global markets, reminding some critics of the blessings of bewilderment.
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 late1990s, a small number of countries, including 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.
Central bankers argue that forward guidance worked, as rock-bottom short-term rates translated into lower long-term rates, bringing down the cost of corporate borrowing and mortgages. Explaining what conditions would cause central banks to tap the brakes gave banks and companies more confidence to lend and invest. Critics say the approach offered mixed messages and created confusion. The foremost 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 global stocks plunge and record surge in Treasury yields that became known as the “taper tantrum.” Forward guidance is evolving as the recovery ushers in a return to higher rates, a reversal that may require central bankers to use all the tricks in the book.
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.
- To hear a podcast of this Quick Take, click here.