(Reuters) – Keeping your word is hard, and people simply hate it when you don’t, something that central bankers enamored of the vogue for “forward guidance” may soon learn.
The Federal Reserve put forward guidance – essentially a pledge or promise to keep policy within certain parameters for a set period of time or given certain conditions being met – at the center of its strategy for keeping control over market interest rates while withdrawing from bond buying. In announcing a $10 billion per month taper, or reduction in bond buying last week, the Fed sweetened the medicine by hardening forward guidance to indicate that rates could remain near zero “well beyond” the time unemployment drops below 6.5 percent so long as inflation remains below a 2 percent target.
In some ways this has worked admirably – markets for risky investments remain upbeat. But in other areas, namely the exchanges where people make bets about future interest rate moves, things seem to be getting away from the Fed.
Back to that in a minute, but first let’s look at why central banks are now so taken with the idea of expectation setting as a monetary policy tool. In part it is because forward guidance is a tool that potentially turns the screws even when rates are near zero, and does so without actually buying anything.
In part though, this is simply the latest in a series of vogues for one technique or another. In the 1980s central banks tried to control the money supply, while more recently it was all about inflation targeting. Whether this was the march of science or the march of folly we will leave history to decide, but change has been a constant.