BOE Governor designate Mark Carney has put a lot of emphasis on forward guidance in talks today. He has used this effectively when he was at the Bank of Canada. The idea is simple and has been followed to some degree by the Fed. Tell investors what you are panning to do not just for today but for the longer-term. If the uncertainty is reduced, markets will adjust faster. It will provide creditability for the central bank and can be an effective tool through helping set forward expectations. This signaling is what the Fed is dong when they state that the zero interest rate policy will be in place for an extended periods. This should translate into lower forward rates.
this works if the central bank has creditability and will follow through on the forward guidance. Of course, there will come a time when forward guidance will change and this can be a dangerous transition in the markets.
Forward guidance also has to be contrasted with the idea of flexible inflation targets. How do you give guidance on your flexibility?
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