At the Jackson Hole conference this weekend, Charlie Bean, deputy governor of the Bank of England, and Frank Smets, head of economic research at the European Central Bank both offered important and newsworthy clarifications of what their respective central banks mean by “forward guidance.”
Bean put it simply: Forward guidance “is intended primarily to clarify our reaction function.” By reaction function he meant a description of how the policy interest rate will react to economic variables; in other words, it’s a monetary policy rule. Bean further clarified that forward guidance at the BoE is not, as some have suggested, a statement that the policy interest rate will be lower in the future than would be appropriate when the future arrives. The intention is not “to inject additional stimulus by pre-committing to a time-inconsistent ‘longer for longer’ policy path,” Bean said.
For the Jackson Hole regulars Bean emphasized that forward guidance at the Bank of England is not what Michael Woodford proposed in a paper at last year’s Jackson Hole conference. Woodford’s widely cited paper called for central banks that are at the zero lower bound for the interest rate to commit to keeping the interest rate at zero well into the future and importantly well beyond the time when economic conditions would call for a rate above zero. Woodford argued that such a commitment on future short rates is needed to get long term interest rates down.
In a separate session at the conference, Frank Smets said essentially the same thing as Bean about the new forward guidance at the ECB, explaining that “We are just trying to be transparent about our policy intentions.” He also emphasized the difference with the Woodford paper of last year.
At least as described by Bean and Smets, BoE and ECB forward guidance is quite different from Fed forward guidance, which has important elements of Woodford’s proposal. The Fed’s policy calls for keeping the interest rate at zero until the unemployment rate gets down to 6.5%. But by that time the best guess of the Fed’s reaction function, based on paper by Janet Yellen, would call for a rate above zero. So there’s the inconsistency that Bean said the BoE wants to avoid.
To be sure, forward guidance at the BoE and the ECB is very new and could change. It is quite possible, however, that it could turn out to be the beginnings of a transition to a rules-based monetary policy. If you listen carefully to Bean and Smets, all their central banks are trying to do is describe a policy rule for the interest rate. Still a long way to go, but they may be on the road out of unconventional monetary policy to a fully articulated rules-based policy.