In this article, We learn about "Forward Guidance".Let's Go!
Forward guidance is a tool used by a central bank to try and influence market expectations of future levels of interest rates.
What’s the Purpose of Forward Guidance?
Forward guidance and quantitative easing (large-scale asset purchases) are the two main unconventional monetary policy tools used to provide further monetary accommodation at the ZLB.
During the GFC, these tools were used together and may have worked in complementary ways.
For example, quantitative easing (“QE”) can convey information about the future path of the policy interest rate (the “signaling channel”), reinforcing the effect of forward guidance.
The credibility of forward guidance is strengthened if the central bank has also embarked in QE.
Many central banks have used forward guidance in recent years to influence interest rate expectations, particularly when rates are at the effective or zero lower bound (ZLB) or close to it.
Forward guidance is also seen as a useful tool for promoting a smooth adjustment when central banks are seeking to return policy rates to normal levels.
Beyond clarifying the central bank’s policy reaction function, forward guidance might cause market interest rates to be less sensitive to economic news if market participants take it as a firm commitment to follow a certain policy path.
But if rates are already at or close to zero, measuring this effect is a challenge: market interest rates could be less responsive to news simply because monetary policy is constrained by the ZLB.
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