‘Forward guidance’ is the central bank buzz-word. Three of the top four central banks in the world have now officially adopted it. And the fourth has already made it very clear where its monetary policy is going. Forward guidance is an attempt by the leading central banks to indicate more clearly what monetary policy will be for a reasonable period ahead along with the conditions for sustaining it. It aims to allow households, businesses and financial markets to know what to expect in central bank base rates for the foreseeable future. In the current environment of low growth, high unemployment and an overhang of capacity, central bankers hope that forward guidance will exert downward pressure on long-term interest rates as economies recover.
Following their December 2012 meeting, US Federal Reserve policymakers announced their new policy of ‘forward guidance’. The Federal Open Market Committee (FOMC) said it forecast that a target range for the federal funds rate of 0-0.25% will be kept for as long as the unemployment rate remained above 6.5%, inflation between one and two years ahead rose no more than 50bp above the FOMC’s target of 2% a year, and longer-term inflation expectations remained ‘well anchored’. The FOMC reckoned that this meant the federal funds rate would be unchanged at least through mid-2015. The thresholds for unemployment and inflation were not trigger points for an immediate change of policy, but points when the FOMC would consider its options.