MacroScope

Forward guidance is not fully living up to its name

January 30, 2014

Britain’s economy may have seen one of the fastest rebounds among industrialized nations last year, but half of 56 economists polled by Reuters think the Bank of England has lost some credibility over its handling of the forward guidance policy.

The policy – an advance notice that monetary conditions will not be tightened too fast or too soon – was a way of managing market bets, at a time when the scope for stimulating economies through conventional interest rate cuts was limited.  Many say it was a necessary transition from the ultra-loose rate policy of recent years to a more normal post-crisis one. Indeed, the use of verbal intervention to guide monetary policy has been on the rise in recent years, as shown by this graphic on the Federal Reserve. 

But the BoE’s forward guidance has come under a lot of criticism and its results have been mixed, as highlighted by this Reuters story  and FT blog.

In a similar poll in November, a slight majority thought the Bank’s handling of its forward guidance framework had damaged faith on in its pronouncements, but the pool of analysts surveyed was smaller.

The improvement in sentiment may have to do with the fact that growth is picking up, unemployment is falling faster than expected and even inflation has come back within target.   

The latest Reuters poll showed a slight majority of British banks – 10 out of 18 – did not think the BoE’s credibility had been hurt by forward guidance. A majority of banks headquartered outside Britain – 20 of 35 – thought it had.

Analysts may have also become sanguine after years of recession and crises led the public and markets to lose faith in the system in general.

According to Sir John Gieve, former deputy governor for financial stability at the Bank of England: 

They will almost certainly have to eat some of their words but complete consistency is not available to mortal man.

Since 2006 … we have had a very vivid international demonstration of the fallibility of economic forecasters and economic policymakers. Against that background, this is a ripple.

But others are frustrated with a policy which was intended to increase clarity, not reduce it. According to Peter Dixon, economist, at Commerzbank:

Nobody would deny the BoE the need to change its assessment when the future pans out differently to expectations. But the forward guidance policy looks set to join the long list of quantitative targets which have been junked when they fail the a priori justification for policy settings – after just six months.

Polling by Hari Kishan and Swati Chaturvedi

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