Is forward guidance dead? Just as Federal Reserve Chair Jerome Powell announced he and his crew would quit telegraphing future interest rate moves last month, he kept jabbering about … future interest rate moves. Other Talking Fed heads followed. This Fed flip-flop exemplifies everything wrong with forward guidance: It threatens central bank credibility while telling investors nothing useful. Members’ views change too frequently and err too often to have ever meant much. The guidance is better with no guidance.
Forward guidance flowered in the late 2000s under Ben Bernanke—a stark shift. Until 1999, the Fed didn’t even issue consistent post-meeting statements. Alan Greenspan openly argued against immediately disclosing rate-change decisions publicly—unthinkable now. Opacity was Greenspan’s goal—his inscrutable “Fedspeak” was designed to obfuscate. “Since I’ve become a central banker, I’ve learned to mumble with great incoherence,” he once quipped. He responded to congressional query beyond their comprehension as in, “If I seem unduly clear to you, you must have misunderstood what I said.” Other Fed heads were similarly cagey. In his 1970 confirmation hearing, Chairman Arthur Burns said “it would be wrong, even immoral” to hint at future Fed moves.
Why so secretive? No one wanted far-flung forecasts anchoring them to future actions—not when conditions could shift. That would make normal policy responses to changing conditions look like bumbling U-turns, stoking uncertainty.
Bernanke thought transparency increased accountability—and reduced uncertainty. Forward guidance became a post-financial-crisis Fed staple imbued with supposed economic wisdom and market mojo. Just tell people where you think the fed-funds rate is heading, and—presto, change-o!—you influence market-set rates, consumption and savings! Businesses can plan better! Investors won’t get spooked by surprise hikes!
Good luck on that! The reality: Conditions change. Forecasts get flubbed—forcing the Fed to abandon its own guidance. Members seemingly say one thing yet do another, the opposite of transparency. Take the 2012 – 2014 “unemployment threshold” saga. In December 2012, Fed guidance called for the fed-funds rate to stay “exceptionally low … at least as long as the unemployment rate remains above 6.5% …” Six months later Bernanke was stressing 6.5% was a threshold, not a trigger, adding that quantitative easing would likely end when unemployment was “in the vicinity of 7%.” But with unemployment nearing those levels in September 2013, he called the jobless rate “not necessarily a great measure” of the labor market. “There is not any magic number that we are shooting for,” he said. Clear as mud! Greenspan’s revenge.
Under Yellen in March 2014, the Fed scrapped the unemployment threshold altogether. She said rate hikes would likely start “something on the order of around six months or that type of thing” after QE’s end. Commentators buzzed, markets wiggled—and by May Yellen was walking back her statement in Congressional testimony. The first hike came in December 2015, about 14 months after QE ended, with unemployment at 5.0%.
The Fed doesn’t monopolize fickle guidance. Numerous U-turns crushed former Bank of England boss Mark Carney’s credibility—one Member of Parliament compared him to an “unreliable boyfriend.” August 2013 BOE guidance stated it would consider rate hikes when UK unemployment reached 7%, which it didn’t expect would happen for two years. Wrong! It hit 7% in February 2014, sparking uncertainty. So the BOE scrapped the threshold, offered new guidance that hikes weren’t likely until 2015 … and four months later Carney said they could come sooner. Nope! The BOE’s next rate move was a 2016 post-Brexit rate cut.
This past year’s global inflation two-step similarly exposed forward guidance as more hindrance than help. Inflation guidance—made before Russia’s Ukraine invasion and subsequent inflation spiral—led to guidance the Fed, ECB and BOE soon ditched. Everyone makes wrong forecasts, me included. But forward guidance cements them into monetary policy expectations, making it hard to switch gears without provoking public ire. Bernanke said forward guidance slowed the Fed’s response to 2022’s inflation. Similar sentiment reigns in Britain, fueling a political backlash. Not that quicker rate hikes would have curbed supply-fueled price jumps, but the conundrum is illustrative.
Central bank jawboning and forecasting don’t prevent surprises and volatility—they often create chaos by intimating course-changing central banks have been caught flat-footed. This raises uncertainty, weighing on sentiment and curtailing risk taking. If investors simply presume the Fed will do what it does when it does it, you probably get more efficient markets and a clearer transmission of monetary policy, unsullied by seemingly contradictory Fed guidance.
It might be different if central banks had ever been consistently keen forecasters. But they’ve never been.
The widely held presumption that the Central Bank, with its army of fancy schooled PhD economists (Eek) and institutionalized processes must surely be wise beyond our collective marketplace knowledge and somehow really “know” is by itself a cultural disservice to us all and negatively impacting cultural norm. With that presumption, held wrongly by many more than not—and as with all things Fed—forward guidance garners outsized importance. Markets did fine without it for eons—they will do just fine from now on if Powell & Co. simply ditch it now. But i bet they won’t.