Forward guidance and expectation formation: A narrative approach

This paper was produced as part of the Final Conference of the BIS-CCA Research Network on "Monetary policy frameworks and communication (2019-2022)".

Summary

Focus

Forward guidance is a central bank statement that provides direct information about the probable state of monetary policy in the future. Its purpose is to influence interest rate expectations. But how exactly does it do so? This is not yet fully understood.

Contribution

To study this issue, I construct central bank data that includes forward guidance and its attributes, central bank projections, and quantitative easing, which I then combine with survey data.  I describe how, when, and where forward guidance works and provide the first empirical evidence of the effects of forward guidance when a central bank makes a commitment.

Findings

I find that forecasters revise their interest rate forecasts in the intended direction by five basis points on average following a change in forward guidance. I provide country estimates for The Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Reserve Bank of Australia, Reserve Bank of New Zealand, Sveriges Riksbank, and Norges Bank. I also provide preliminary evidence that commitment-based forward guidance is exceedingly rare, but can strongly amplify forward guidance. Finally, I provide estimates of the extent to which this effect may be attributable to central bank information effects.

Abstract

How forward guidance influences expectations is not yet fully understood. To study this issue, I construct central bank data that includes forward guidance and its attributes, central bank projections, and quantitative easing, which I combine with survey data. I describe how, when, and where forward guidance has worked. I find that forecasters revise their interest rate forecasts in the intended direction by five basis points on average following a change in forward guidance. I provide country estimates for The Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Reserve Bank of Australia, Reserve Bank of New Zealand, Sveriges Riksbank, and Norges Bank. I offer preliminary evidence that commitment-based forward guidance is exceedingly rare, but can strongly amplify forward guidance. Finally, I provide estimates of the extent to which this effect may be attributable to central bank information effects.

JEL classification: D83, D84, E37, E52, E58.

Keywords: forward guidance, central bank communication, information effects, expectations, survey data.