The Emergence of Forward Guidance As a Monetary Policy Tool

Forward guidance—the issuance by a central bank of public statements concerning the likely future settings of its policy instruments—is widely regarded as a new tool of monetary policy. The analysis in this paper shows that Federal Reserve policymakers from the 1950s onward actually accepted the premises of forward guidance: the notion that longer-term interest rates are key yields in aggregate spending decisions; and the proposition that indications of intentions regarding future short-term interest rate policy can affect longer-term rates. Over the same period, they were nevertheless wary about providing forward guidance regarding short-term interest rates, fearing that this could generate untoward market reactions or lock the Federal Open Market Committee into inappropriate rate settings. They concentrated on describing future policy in terms of achievement of economic objectives, with their commentary on interest-rate prospects usually confined to consideration of the longer-term factors affecting rates. Even in these years, however, there were infrequent occasions—notably in 1974 and 1982—when policymakers provided more explicit guidance regarding the path of short-term rates. In the 1990s, a consensus developed in U.S. policy circles that was more receptive toward the notion of guiding longer-term interest rates by providing indications of future FOMC actions. This consensus developed even before concerns about the lower bound on short-term rates became prevalent in U.S. policymaking. The new mindset, which stressed the stabilizing effects on the economy of communication of policy intentions, set the stage for the emergence of forward guidance as a monetary policy tool.