2014 Forward guidance and communication about unconventional monetary policy

17th Annual DNB Research Conference on  “Forward guidance and communication about unconventional monetary policy”, 13-14 November 2014

In the wake of the global financial crisis the ECB and other major central banks have engaged in unconventional monetary policy measures. Moreover, forward guidance about policy rates has become more widespread and important, including for the ECB. This year’s Annual DNB Research conference focussed on the effects and challenges in the design of forward guidance about policy rates and communication about unconventional monetary policy. The program of the conference is available at the link http://www.dnb.nl/en/onderzoek-2/test-conferences/annual-research-conferences/programmes/dnb299690.jsp .
 
In several economies, including the euro area, the United Kingdom and the United States, central banks reduced policy rates to levels close to zero to counter the economic downturn due to the recent financial crisis. Even when policy rates are close to zero, monetary policy may still be effective through unconventional monetary policies, such as purchases of assets and liquidity support by the central bank, and by communication about the future path of policy rates, better known as forward guidance. But the effectiveness of these measures is still controversial and not well understood. 
The conference was opened by Klaas Knot, DNB president, who introduced the topic of the conference and highlighted its relevance for the DNB and the Eurosystem. The four sessions of the conference included keynote lectures on forward guidance by policymakers in the United States and the United Kingdom who were closely involved in designing forward guidance there, namely Charles Evans (President, Chicago Fed) and David Miles (Monetary Policy Committee member, Bank of England). It discussed the experiences with quantitative forward guidance introduced already before the crisis, such as in Sweden; and the effects of forward guidance introduced in the wake of the crisis, including its effects on the real economy. It also covered international spillovers, in particular how communication about unconventional monetary policy in the United States and the euro area has affected emerging economies. The conference also included a policy panel on ‘Challenges in designing forward guidance about policy rates and communication about unconventional monetary policy’, with panellists including Charles Goodhart (London School of Economics), William Nelson (Federal Reserve Board) and Frank Smets (ECB). 
 
Charles Evans gave the first keynote address on the role of forward guidance in monetary policy communications. David Miles gave the second keynote address on ‘What is the right amount of guidance? The Experience of the Bank of England with forward guidance’. He argued that attempting to provide a specific central path with probability bands may go beyond what is feasible and useful, and provide spurious accuracy. He noted that the public can confuse central expectations with promises by central banks, as they had done in the United Kingdom. He concluded that currently, it might be just as useful – and probably less misleading and possibly even more accurate – to give forms of guidance which are more qualitative, such as “interest rate rises will probably be gradual and likely to be to a level below the old normal”.
 
The policy panel focused on challenges in designing forward guidance about policy rates and communication about unconventional monetary policy. Charles Goodhart noted that it was not possible to forecast beyond six months ahead, and that it was not possible to commit a monetary policy committee to future action on policy rates, due to individualistic voting and a changing composition of the committee. Forward guidance could nevertheless be useful at the zero lower bound, in state-contingent rather than time-contingent form, and to prevent a spike in long-term interest rates on exit. William Nelson noted that the objective of forward guidance was to increase transparency and provide economic stimulus in recent years. Challenges of forward guidance included that is was difficult to avoid the misimpression that date‐based or even qualitative guidance was a commitment, and that lengthening the guidance period could damage confidence in the economic outlook. Moreover, the tapering episode illustrated the challenge associated with providing guidance about two different policy tools, the policy rate and asset purchases. 
 
Papers in the first session discussed effects of forward guidance and unconventional monetary policy. Tomasz Wieladek (Bank of England) presented a paper with Tomas Key and Martin Weale on ‘The interest rate uncertainty channel of unconventional monetary policy’. Jakob de Haan (DNB) and Richhild Moessner (DNB) presented the second paper in this session with David-Jan Jansen on ‘The effect of forward guidance and the zero lower bound on interest rate sensitivity to economic news in Sweden’. They find that the sensitivity of interest rate swaps to Swedish macroeconomic news was not significantly affected by the Riksbank’s introduction of forward guidance in 2007, which suggests that markets understood the conditionality of the Riksbank's policy rate forecasts, and did not take them as unconditional commitments.
Papers in the second session focussed on the macroeconomic effects of forward guidance. Marco Del Negro (New York Fed) presented a paper with Marc Giannoni and Christina Patterson on ‘The Forward Guidance Puzzle’. The paper finds that standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy – a phenomenon they call the “forward guidance puzzle". The paper explains why this is the case and describes one approach to addressing this issue. Philippe Andrade (Banque de France) presented a paper with Gaetano Gaballo, Eric Mengus and Benoit Mojon on ‘Heterogeneous Beliefs and Forward Guidance’. The paper presents facts suggesting that private agents disagreed on the interpretation of forward guidance as ‘Odyssean’ (ie with commitment by the central bank) or as ‘Delphic’ (ie without commitment). It introduces heterogeneous beliefs in a standard New-Keynesian model at the zero lower bound. It finds that heterogeneous beliefs can hamper Odyssean forward guidance, and potentially lead to adverse effects from Odyssean announcements.
 
The Federal Reserve’s announcements starting in May 2013 that it might begin reducing its bond purchases sooner than previously expected (tapering) may have contributed to devaluing currencies and falling equity prices of emerging market economies, as discussed in a paper by Barry Eichengreen and Poonam Gupta presented in the third session. The paper finds that better macroeconomic fundamentals did not insulate the countries during the tapering talk, and that size mattered, with larger markets affected more. One of the conclusions of the paper is that emerging markets, especially the larger markets, need to manage capital flows. Peter McQuade (Trinity College Dublin) presented the second paper in this session with Matteo Falagiarda and Marcel Tirpak on ‘Spillover effects of the ECB monetary policy on selected non-euro area EU countries: Evidence from an event-study and a BVAR’.
 
Papers in the last session addressed the issue of signalling and unconventional monetary policy. Signe Krogstrup (Swiss National Bank) presented her paper with Jens Christensen on ‘Swiss Unconventional Monetary Policy: Lessons for the Transmission of Quantitative Easing’. They find that quantitative easing announcements by the Swiss National Bank were associated with declines in the term premiums of long-term Swiss bonds. Since the Swiss National Bank bought no long-term bonds, they interpret this as evidence of portfolio balance effects of reserve expansions on long-term yields. Saroj Bhattarai (University of Texas at Austin) presented a paper with Gauti Eggertsson and Bulat Gafarov on ‘Time Consistency and the Duration of Government Debt: A Signalling Theory of Quantitative Easing’. The paper presents a signalling theory of quantitative easing in which open market operations that change the duration of outstanding nominal government debt affect the incentives of the central bank in determining the real interest rate.

Participants in this conference included senior policymakers from many central banks which introduced or enhanced forward guidance in the wake of the global financial crisis, or that have a longer experience with publishing policy rate forecasts.  Participants in this conference also included leading academics, which allowed for a fruitful interaction between researchers, policymakers and policy economists, which will provide useful insights for future work here at DNB and within the Eurosystem on forward guidance and communication about unconventional monetary policy.