Forward Guidance Research Articles

The economic impact of yield curve compression: Evidence from euro area forward guidance and unconventional monetary policy

Unconventional monetary policies have now been part of the toolkit of developed economy central banks for well over a decade. The question of how their effects have changed over time is therefore an important one. This paper studies the impact of multiple forms of monetary policy surprise for the case of the ECB. I employ a semi-parametric time-varying VAR-X framework, which allows one to chart the changing responses of a broad range of financial and macroeconomic variables simultaneously. I develop high-frequency series that separate forward guidance from yield curve compression surprises — the use of the latter allows one to learn about the effects of flattening yield curves through the history of the ECB, including those induced by its Expanded Asset Purchase Programme (APP). Forward guidance surprises are found to have their maximum impact on inflation when these policies were linked to the duration of the APP. Yield curve compression surprises are shown to transition from largely financial effects on equity markets and risk, to having a greater effect on prices at the time of the APP. However, the maximal effect of the APP on prices is found to occur after its maximal effect at flattening the yield curve, indicating delayed transmission.

Alternative Monetary Policy Commitments and the Yield Curve*

We present a simple model to characterise central bank forward guidance, large‐scale asset purchases and yield curve control. Endogenous yield curve reactions to policy shocks are a key determinant of monetary conditions and can support or offset policy intentions. Alternative monetary policy tools allow the central bank to signal central bank private information to investors when the policy rate is at the effective lower bound, shaping yield curve reactions. Commitments to these tools offer policy certainty but can become time‐inconsistent if the economy recovers sooner than expected. If commitments become time‐inconsistent, endogenous yield curve tightening can offset excess stimulus. The strength of this offset, and the optimality of monetary conditions, improves with the precision of investor inferences of central bank private information.

Synthetic cap rate indices (1991-Covid era)

We introduce a method that combines Euclidean distancing and OLS techniques to project synthetic capitalization rate indices (‘SCXs’) for metropolitan statistical areas in the US. SCXs are projected independently of market prices, asset specific characteristics and geographic location (ex-ante). In contrast to market cap rates, driven by geographic proximity and market comparables, our new method is driven by economic proximity. We find SCXs provide better forward guidance than market cap rates for commercial real estate (‘CRE’) defaults and CRE values before and during the Covid pandemic. Our method establishes CRE benchmark cap rate indices across property types that explicitly connect CRE valuation at the MSA level to macroeconomic indicators through economic proximity.

Impacts of Monetary Policy Shocks on Inflation and Output in New Zealand*

We identify monetary policy shocks in New Zealand as 1‐day changes in the whole yield curve around monetary policy announcements. The impacts of these shocks on inflation and output are estimated using functional local projections. We find that the effects of monetary policy shocks are standard in the short run but might be different in the long run. Monetary policy shocks in a small open economy have similar effects as in a large economy, except that unconventional monetary policy announcements have limited impact on long‐term interest rates. Accounting for forward guidance, used in New Zealand since 1997, is important.

Estimating the Fed’s unconventional policy shocks

Financial market responses to Fed monetary policy announcements are often very small, but sometimes very large and the mix of news contained in these announcements varies over time. I exploit these features of the data to estimate different types of Fed policy shocks. The resulting shocks can be naturally labeled as standard monetary policy, Odyssean forward guidance, large scale asset purchases and Delphic forward guidance. They affect risk-free interest rates, stock prices and the dollar on impact and have delayed but pronounced effects on corporate bond spreads and breakeven inflation rates.

Quantifying Forward Guidance and Yield Curve Control

Quantifying Forward Guidance and Yield Curve Control

Unconventional Monetary Policy and Long‐Term Interest Rates

AbstractThis paper constructs a survey‐based measure capturing the evolution of market's expectations of the Federal Reserve's Large‐Scale Asset Purchases (LSAP) program during 2008–18, and examines the transmission mechanism of unconventional monetary policy. Estimation results suggest that both signaling and portfolio balance channels of the LSAP were important in lowering long‐term interest rates; Moreover, the Federal Reserve's forward guidance policy had led to a gradual extension of market's projections of the duration of the LSAP, making its effects more persistent. Model estimation also explains the 2013 taper tantrum well, and suggests that the LSAP's effects might have declined during QE III.

Estimating a Behavioral New Keynesian Model with the Zero Lower Bound

AbstractWe estimate a New Keynesian model incorporating two notable features: bounded rationality and the zero lower bound on the nominal interest rate. Our Bayesian estimation of a nonlinear model shows that the model with bounded rationality better fits the U.S. data than its rational expectations counterpart, and that both households and firms exhibit a substantial degree of bounded rationality. Moreover, we demonstrate that bounded rationality expands a parameter region in which the model can be estimated and weakens the power of forward guidance.

The global spillovers of unconventional monetary policies on tail risks

This article analyzes the risk spillovers of UMPs of four major central banks on the expectations of a market crash in foreign equity markets. The empirical findings show that forward guidance measures exhibit a significant cross-border impact on tail risks. Other expansionary UMPs are innocuous on inducing risk spillovers to other economies. A classification of reversal UMPs into contractionary and tapering provides opposite conclusions: contractionary UMPs shocks exhibit a strong and negative cross-border impact on the tail risks of other economic areas, contrary to tapering announcements. Both the Fed and ECB unconventional policies induce significant risk spillovers with similar magnitudes.

Responses of Swiss interest rates and stock prices to ECB policy surprises

We employ local projections to analyse the responses of Swiss asset prices to scheduled policy decisions of the European Central Bank (ECB) as a case study of ECB policy spillovers to European countries outside the euro area. Focusing on ECB policy shocks that are related to different policy instruments of the ECB, our empirical results leave the impression that surprises related to the ECB target policy rate and to the ECB’s longer-term forward guidance or its asset purchases tend to move Swiss interest rates and stock prices in the same direction. Shocks explicitly designed to capture pure ECB monetary policy and information effect shocks are weakly associated with movements in Swiss asset prices on average.

Optimal forward guidance in monetary policy: Can central banks sway the public with projections?

Abstract Because economic outcomes depend on private-sector expectations, central banks might be tempted to guide these by publishing projections of key macroeconomic variables. We find that optimal projections require misleading the public. Optimal non-misleading projections are time-inconsistent. Non-misleading time-consistent projections can only improve policy outcomes if the public’s forecasts are noisier, or inconsistent with implemented policy. Since the public only has incentives to be guided by policymakers’ projections when most vulnerable to being mislead, these cannot be trusted blindly. Consistent with this, we find statistically significant systematic deviations between FOMC projections and professional forecasts for US inflation and GDP growth.

Bounded rational expectation: How it can affect the effectiveness of monetary rules in the open economy

Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.

Is forward guidance an effective policy: A time-varying analysis

Forward guidance has increasingly become a crucial tool for central bank. We aim to analyze the dynamic impact of forward guidance in China by utilizing high-frequency identification methods. The findings indicate that forward guidance is an effective policy tool. Forward guidance can effectively influence the policy rate, reduce uncertainty in monetary policy, mitigate frictions in financial markets, and stimulate the real economy. In regard to its dynamic effects, forward guidance can effectively contribute to counter-cyclical regulation. Furthermore, forward guidance exerts a substantial influence on financial markets, contributing to the reduction of potential risks and financing constraints.

Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance, and Inflation Dynamics Post-Global Financial Crisis

Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance, and Inflation Dynamics Post-Global Financial Crisis

Credible Forward Guidance

How can the central bank credibly implement a “lower-for-longer” strategy? To answer this question, we analyze a series of optimal sustainable policy problems—indexed by the duration of reputational loss—in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates. We find that, even when the central bank lacks commitment, the central bank can still credibly keep the policy rate at the ELB for an extended period—though not as extended as under the optimal commitment policy—and meaningfully mitigate the adverse effects of the ELB constraint on economic activity.

What does anticipated monetary policy do?

Applying sign restrictions to measures of expectations in a VAR, we quantify the economic effects of imperfectly and perfectly anticipated monetary policy innovations—the type of shocks induced by partially and fully credible forward guidance (FG). We find that fully credible FG one-year ahead has large near-term effects on prices and real activity, but, consistent with the forward guidance puzzle, these effects do not grow much larger as the FG horizon extends into the future. We also estimate that anticipated policy innovations are very noisy. At the one-year horizon, over 70 percent of the monetary-policy signal consists of noise, and the prevalence of noise increases at longer horizons. FG subject to this level of noise would be only partially credible and have significantly smaller macroeconomic effects.

Density forecasting of conjunctivitis burden using high-dimensional environmental time series data

As one of the most common eye conditions being presented at clinics, acute conjunctivitis puts substantial strain on primary health resources. To reduce this public health burden, it is important to forecast and provide forward guidance to policymakers by estimating conjunctivitis trends, taking into account factors which influence transmission. Using a high-dimensional set of ambient air pollution and meteorological data, this study describes new approaches to point and probabilistic forecasting of conjunctivitis burden which can be readily translated to other infectious diseases. Over the period of 2012 – 2022, we show that simple models without environmental data provided better point forecasts but the more complex models which optimized predictive accuracy and combined multiple predictors demonstrated superior density forecast performance. These results were shown to be consistent over periods with and without structural breaks in transmission. Furthermore, ecological analysis using post-selection inference showed that increases in SO2, O3 surface concentration and total precipitation were associated to increased conjunctivitis attendance. The methods proposed can provide rich and informative forward guidance for outbreak preparedness and help guide healthcare resource planning in both stable periods of transmission and periods where structural breaks in data occur.

The Announcement Effect of Monetary Policy on the Corporate Bond Markets

This study investigates the impact of the central bank’s monetary policy announcements on the perceptions of yield spread in corporate bond markets under the event of extreme events. These results highlight that the coronavirus pandemic has caused a market panic in the global economy. This caused investors to withdraw their money from bond markets, which caused a liquidity crisis in bond markets. The Fed announcements caused statistically significant tightening on US and global investment grades and high-yield corporate bond spreads. The Euro investment grade and high-yield corporate bond spread narrowed when the Fed took additional actions to provide more funds and expanded the buying scope to support market liquidity. These results suggest that forward guidance that emphasizes the Fed’s monetary policy causes stronger information effects.

The power of forward guidance: The role of social transfer

We examine the relationship between the generosity of social transfer and the stimulative effect of forward guidance. Increasing social transfer makes households less concerned about income risk, making them more responsive to future changes in interest rates. To assess this possibility quantitatively, we construct a New Keynesian incomplete market model economy that includes social transfer. The results show that the stimulative effect of forward guidance is stronger in the model economy with twice the level of social transfer than in the model economy with the current level of United States’ social transfer.

Impact of RBI's monetary policy announcements on government bond yields: evidence from the pandemic.

We investigate how the bond market responded to the Reserve Bank of India's (RBI) monetary policy actions undertaken since the start of the pandemic. Our approach involves combining a narrative analysis of the media coverage together with an event-study framework around RBI's monetary policy announcements. We find that the RBI's actions early in the pandemic were helpful in providing an expansionary impulse to the bond market. Specifically, long-term bond interest rates would have been meaningfully higher in the early months of the pandemic if not for the actions undertaken by the RBI. These actions involved unconventional policies providing liquidity support and asset purchases. We find that some of the unconventional monetary policy actions had a substantial signaling channel component where the market perceived the announcement of an unconventional monetary policy action as representing a lower future path for the short-term policy rate. We also find that the RBI's forward guidance was more effective in the pandemic than it had been in the couple of years preceding the pandemic.