In a piece written for the CEPR pamphlet "Is Inflation Targeting Dead? Central Banking After the Crisis", former Bank of England Monetary Policy Committee member Adam Posen has dismissed the idea of forward guidance for monetary policy as a "gimmick".
Forward guidance is the idea that a monetary policy committee can pre-commit to a certain course of policy in order to drive outcomes in the direction they want. It's a particularly trendy idea right now, driven, Posen writes, "by the question about whether central banks should be explicitly focusing on GDP (or unemployment) as well as inflation".
If forward guidance works as it should, then a bank can boost the economy by assuaging fears amongst investors that monetary policy will be tightened shortly. Armed with that guidance, they will (ideally) go off and take actions which strengthen the economy, which they may not have taken if they were expecting an imminent rise in interest rates.
But Posen points out that that rarely happens. He cites three examples, in Canada, Sweden and the US, where forward guidance has been issued, but later statements from the central bank have served to instil doubt in the markets. For instance, in the US:
The Federal Reserve recently embraced a version of pre-commitments when the FOMC announced in November 2012 that they were switching to a ‘thresholds model’. Namely, they would not raise rates until unemployment fell unless the inflation threshold was violated.
I think that was the right stance of policy. Then we saw the next month, based on some comments in the minutes from the FOMC meeting, the market sold off.
His evidence is backed up by the fact that in the UK – where pre-commitment is explicitly foresworn – "the impact of quantitative easing was very closely comparable… to that of the US". As a result, Posen, writes, "the bottom line lesson… is that talk is cheap."
Of course, it may still be the case that in some hypothetical situation where the central bank managed to release a series of statements which were all consistent with the forward guidance in the eyes of the market that the policy would have the desired effect. But, he argues, "believing that jawboning had some effect is not the same as believing that it is an independent tool of monetary policy with a lasting and credible effect."
The intervention may come as a disappointment to incoming Bank of England governor Mark Carney. Posen explicitly calls out Carney for placing too much faith in forward guidance, and attributes it to "frustration – the lack of recovery despite massive monetary-policy shifts." It's certainly true that many of Carney's supporters are hoping that this will be the policy shift which actually works, but Posen provides a hope of his own:
The fact is we could have pursued more aggressive monetary policy, achieved better goals and been totally consistent with the current inflation target…
Forward guidance is no substitute for sufficient policy action.