Central banks often make statements about the likely future path of interest rates by providing so-called forward guidance. Forward guidance is especially used if the central bank can no longer cut policy rates because they are already as low as possible (i.e. they have reached their lower bound). In this case, central banks can further “ease” monetary policy by managing expectations about the future course of policy rates. Via forward guidance, central banks provide additional information regarding their likely response to economic developments, which can anchor expectations about future policy rates and reduce uncertainty.
The type of forward guidance matters
Forward guidance can be implemented in different ways. Three types of guidance have been dominant in the recent past:
Open-ended forward guidance is a purely qualitative statement about the policy path. An example is the ECB’s statement used between July 2013 and January 2016 that “we expect the key ECB interest rates to remain at present or lower levels for an extended period of time.”
Data-based forward guidance outlines a policy path conditional on economic outcomes. The ECB’s current forward guidance, for example, contains such an element, as the key policy rates are expected to remain at their present levels “for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.”
Calendar-based forward guidance is a policy path with an explicit reference to a calendar date. An example is the current guidance by the ECB, that key policy rates are expected to remain at their present levels “at least through the first half of 2020.”