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Forward Guidance at the Effective Lower Bound: International Experience

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  • Karyne B. Charbonneau
  • Lori Rennison

Abstract

Forward guidance is one of the policy tools that a central bank can implement if it seeks to provide additional monetary stimulus when it is operating at the effective lower bound (ELB) on interest rates. It became more widely used during and after the global financial crisis. This paper reviews the international experience, based on the six central banks that have used forward guidance when operating at the ELB, in order to assess its effectiveness and the potential risks associated with its implementation. We distinguish between three distinct types of forward guidance (qualitative, time contingent and state contingent) and discuss the channels through which forward guidance operates. Overall, we find that forward guidance can be an effective tool at the ELB when clearly communicated and perceived as credible. Though evidence from the literature is somewhat mixed—since the specific effects vary across economies, episodes and type of guidance—it has generally been found to be effective in (1) lowering expectations of the future path of policy rates, (2) improving the predictability of short-term yields over the near term and (3) changing the sensitivity of financial variables to economic news. However, as with other monetary policy tools, the benefits of forward guidance need to be weighed against the costs. Those costs are mainly associated with potential loss of credibility and increased financial stability risks. Moreover, the international experience with forward guidance under conditions of negative ELBs and interest rates is limited to date.

Suggested Citation

  • Karyne B. Charbonneau & Lori Rennison, 2015. "Forward Guidance at the Effective Lower Bound: International Experience," Discussion Papers 15-15, Bank of Canada.
  • Handle: RePEc:bca:bocadp:15-15
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    References listed on IDEAS

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    1. Bo Young Chang & Bruno Feunou, 2013. "Measuring Uncertainty in Monetary Policy Using Implied Volatility and Realized Volatility," Staff Working Papers 13-37, Bank of Canada.
    2. Eric T. Swanson & John C. Williams, 2014. "Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates," American Economic Review, American Economic Association, vol. 104(10), pages 3154-3185, October.
    3. Richhild Moessner & Jakob de Haan & David-Jan Jansen, 2014. "The effect of the zero lower bound, forward guidance and unconventional monetary policy on interest rate sensitivity to economic news in Sweden," DNB Working Papers 413, Netherlands Central Bank, Research Department.
    4. Sharon Kozicki & Eric Santor & Lena Suchanek, 2011. "Unconventional Monetary Policy: The International Experience with Central Bank Asset Purchases," Bank of Canada Review, Bank of Canada, vol. 2011(Spring), pages 13-25.
    5. Stephen S. Poloz, 2014. "Integrating Uncertainty and Monetary Policy-Making: A Practitioner’s Perspective," Discussion Papers 14-6, Bank of Canada.
    6. Andersson, Magnus & Hofmann, Boris, 2009. "Gauging the effectiveness of quantitative forward guidance: evidence from three inflation targeters," Working Paper Series 1098, European Central Bank.
    7. Rhys R. Mendes & Stephen Murchison, 2014. "Should Forward Guidance Be Backward-Looking?," Bank of Canada Review, Bank of Canada, vol. 2014(Autumn), pages 12-22.
    8. Katherine Femia & Steven Friedman & Brian P. Sack, 2013. "The effects of policy guidance on perceptions of the Fed’s reaction function," Staff Reports 652, Federal Reserve Bank of New York.
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    1. repec:ovi:oviste:v:xvii:y:2017:i:2:p:537-541 is not listed on IDEAS

    More about this item

    Keywords

    Monetary policy framework; Monetary policy implementation; Transmission of monetary policy; Uncertainty and monetary policy;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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