Friday, January 25, 2008

Forward Guidance

"'Forward guidance' is communcation by a central bank [CB] aimed at signalling the likely future path of policy rates. All of the big-3 [CBs] (the Fed, Bank of Japan and the ECB) have experimented over recent years with more explicit forward guidance through their official communications. ... Is it in fact appropriate for [CBs] to try to communicate about future interest rates, or is this a point on which they are better advised to say as little as possible. ... The economic effects of monetary policy depend almost entirely on the anticipated future path of the policy rate, rather than on the current level itself of a rate such as the federal funds rate; announced changes, or non-changes, in the funds rate operating target matter only to the extent they often imply changes in the expected path of the funds rate months or even years into the future", Michael Woodford (MW) Columbia University professor at, 17 January 2008.

I agree with MW's conclusion "the anticipated future path of the policy rate" as this is consistent with the "rational expectations" hypothesis. I disagree with MW about his apparent goal in writing the article, i.e., it is desireable for a CB to control anything. If you assume a CB is good, you may want it to control "the economy" to the extent it can. If you assume: the CB exists to redistribute wealth from monetary claims holders to debtors, you see anything aiding the CB in its mission as undesireable. Besides, how can a CB do anything unless "the anticipated future path of the policy rate" is wrong! Absent market errors, the CB cannot redistribute anything! Therefore the CB must deceive the market to effect its policy preferences! As I read in Barron's in 1979, "How do you know when the Chairman of the Fed is lying? Every time he moves his lips"! I await MW's comment on the Fed's recent 75 basis point interest rate cut.

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