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The other side of forward guidance: Are central banks constrained by financial markets?

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  • Picault, Matthieu
  • Raffestin, Louis

Abstract

We present a theoretical model in which the central bank cares about the short-term stability of financial markets, which gives it an incentive to keep market expectations about future rates at a low level. This incentive is stronger when financial institutions are perceived to be fragile, because the impact on financial stability of a rise in rate expectations is higher in that context. Empirically, both the long-term target of the central bank and the short-term health of the financial sector are strong predictors of the evolution of US Treasury notes rates between two central bank meetings.

Suggested Citation

  • Picault, Matthieu & Raffestin, Louis, 2020. "The other side of forward guidance: Are central banks constrained by financial markets?," Finance Research Letters, Elsevier, vol. 36(C).
    • Handle: RePEc:eee:finlet:v:36:y:2020:i:c:s1544612319301321
    DOI: 10.1016/j.frl.2019.101324
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    More about this item

    Keywords

    Forward guidance; Central bank; Financial stability; Market expectations;
    All these keywords.

    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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