Since the beginning of this year, as global inflation levels have continued to rise, European and American central banks have started the process of raising interest rates and . At the same time, they also stated that they would abandon "forward guidance", triggering heated discussions in the market. Whether to maintain a sense of mystery or to maintain transparency has always been a multiple-choice question that central bank needs to face.
Former Chairman of the Federal Reserve Alan Greenspan (Alan Greenspan) is the representative of the former. As he said, "If you think you understand what I mean, then you must have understood it wrong."
And Ben Bernanke (Ben Bernanke), who succeeded Greenspan, is more willing to lift the mystery of the Federal Reserve. Since the Bernanke era, forward guidance has become a tool for the Federal Reserve to convey its monetary policy goals to the market.
However, the forward-looking guidance that was once "relied on" may soon be "abandoned". In this week's highly anticipated annual meeting of global central banks in Jackson Hole, Federal Reserve Chairman Jerome Powell will speak at the annual meeting on August 26 to discuss the economic outlook. . The market expects that this meeting may officially announce the end of the Fed's "forward guidance" policy.
So, what is forward guidance? How does forward guidance work? Why did it fall into the situation of being "abandoned"? In this issue of the Encyclopedia, we will talk about those things about "forward guidance."
1. What is forward guidance?
Forward guidance is a tool that can change future expectations, that is, it releases information on the direction of the central bank's monetary policy to the market in advance to guide market expectations and make market expectations consistent with the central bank's guidance expectations.
In 2003, Michael Woodford and Gauti Eggertsson formally proposed the term "forward guidance" and stated that the central bank's forward guidance can affect the short-term market in the future. Interest rate expectations, and by extension long-term market interest rates, will ultimately affect current consumer spending behavior.
After the 2008 financial crisis, was used more with forward guidance, and many central banks elaborated on its definition.
The Federal Reserve believes that forward guidance is the central bank ’s communication with the public about the possible direction of future monetary policy. Individuals and businesses use the information provided by forward guidance when making spending and investment decisions that influence current financial and economic conditions.
The European Central Bank believes that forward guidance refers to statements that attach conditions to the future path of policy rates. It not only contains the results of the ECB Governing Council's assessment of current economic conditions and risks to medium-term price stability, but also conveys what this assessment means for future monetary policy trends.
The Bank of England believes that forward guidance is the clear guidance provided by the Monetary Policy Committee on the path of future monetary policy. It provides more information to help people understand the conditions that need to be met to maintain the current monetary policy and effectively stimulate the economy.
The Bank of Japan believes that forward guidance is a communication strategy for the central bank to provide information to the market about its future monetary policy stance.
To summarize, forward guidance is a way for the central bank to manage expectations and is a way for the central bank to communicate with the public about the direction of future policies. Especially in the special period when the policy interest rate is close to the zero lower limit, there is no room for lower interest rates. At this time, forward guidance can be used in conjunction with the quantitative easing policy to achieve the central bank's regulatory goals.
2. How does forward guidance work?
For example, if the interest on borrowing money from the bank is zero this year, then I will most likely not borrow money because I am not sure how the interest will change next year.If the bank tells me that the interest rate will be zero for the next ten years, then I will most likely borrow some money to invest in building a factory, because I don’t have to worry about high interest costs in the future. The reason why forward guidance can work under the zero interest rate constraint can also be understood as the central bank sending a signal to lower "long-term interest rates."
There are four main ways for forward guidance to work:
First, forward guidance - future interest rate expectations - total output. The central bank uses policy signals to influence expectations of short-term interest rates, which in turn affects long-term interest rates. If long-term interest rates remain low, it will stimulate a long-term increase in consumption and investment, thereby stimulating the economy.
The second is forward guidance—prices of financial assets such as stocks—total output. The central bank releases signals of future loose monetary policy through forward-looking guidance, which will cause market investors to lower their expectations for short-term interest rates, which will cause the prices of financial assets such as stocks to rise. According to Tobin's Q theory and Modigliani's constant income effect, rising financial asset prices will promote consumption and investment, thereby stimulating the economy.
The third is forward guidance - market interest rate - total output. Generally speaking, short-term interest rates, namely base interest rate , are the basis for market interest rates. Theoretically, all interest rates should move in the same direction as the base rate. After the central bank makes policy commitments, it can keep the benchmark interest rate at a low level in the long term, thereby keeping other short-term interest rates at a low level for a certain period of time, thereby stimulating aggregate demand and real output.
The fourth is forward guidance - inflation level - total output. If the central bank sets an inflation target, and the market also has great trust in the central bank's commitment. The policy's sustainability expectations will continuously correct the deviation between the public's expected inflation level and the policy target, so that the public's expected inflation rate matches the policy target level set by the central bank. As long as inflation remains low, central banks will generally not rashly raise policy rates. As long as low interest rates persist, they will have a positive effect on demand expansion and output growth.
3. The practical experience of Japan and the United States in forward-looking guidance
In terms of forward-looking guidance, Japan is the pioneer and the United States is the winner.
Let’s talk about Japan first.
In the early 1990s, the Japanese stock market and property market bubbles burst, the economy suffered heavy losses, and inflation continued to decline. Subsequently, a large number of companies collapsed and the balance sheets of financial institutions were seriously damaged. The economy fell into recession in the second half of the 1990s and faced continued deflationary pressure. Businesses and the public gradually lost confidence. As a result, the Bank of Japan continued to lower policy interest rates. In August 1990, the interest rate was 6%, which fell to 0.25% in September 1998. In February 1999, the nominal interest rate had dropped to zero, and the economy fell into a liquidity trap. Monetary policy space is exhausted.
In this regard, Krugman suggested that the Japanese government get out of the predicament by creating expectations of inflation. Next, the Bank of Japan adopted a series of unconventional monetary policy tools , including "forward guidance", large-scale asset purchases, etc. But forward guidance at that time was still in the exploratory stage.
In April 1999, two months after adopting the zero interest rate policy, the Bank of Japan introduced vague forward guidance and announced that it would "maintain the zero interest rate policy until deflationary pressures are eliminated." Because deflation is not clearly defined, it has little effect.
In 2001, due to the deflation risk caused by the bursting of the Internet bubble , the Bank of Japan announced that it would continue to implement easing policies until the core CPI stabilized at or above zero level year-on-year. This round of quantitative easing and forward-looking guidance have achieved certain results, and core CPI began to turn positive in 2005. Subsequently, the Bank of Japan ended its quantitative easing policy in March 2006.
Affected by the global financial crisis in 2008, the Bank of Japan adopted a broad easing policy in 2012, announcing that it would maintain an ultra-loose policy until the CPI increased by 1% year-on-year, and pointed out that 1% was the current target, and the medium- and long-term inflation target was 0-2 % interval.In January 2013, the Bank of Japan officially set the inflation target at 2% and stated that it would not set an exit period for the quantitative easing policy. In April 2013, the Bank of Japan launched the "Qualitative and Quantitative Easing Monetary Policy" (QQE) and promised to raise prices to a target of 2% within two years.
In September 2016, the Bank of Japan adjusted its qualitative and quantitative easing policy from an adjustment in the quantity of money to an adjustment in interest rates, especially long-term interest rates. It announced that it would maintain the negative interest rate policy of -0.1% for short-term deposits and maintain long-term interest rates. With zero as the policy target, it states that "the Bank will expand the base money supply until the observed year-on-year increase in the consumer price index exceeds the price stability target of 2% and remains above this target in a stable manner."
In order to continue to implement strong monetary easing policies, in July 2018, the Bank of Japan decided to strengthen its commitment to achieving price stability goals by introducing forward guidance on policy interest rates, as well as improving "quantitative and qualitative monetary control through yield curve control" Continuity of Easing (QQE)", stating that "given the uncertainty about economic activity and prices, the central bank intends to maintain short-term and long-term interest rates at their current extremely low levels for an extended period of time."
Although Japan continues to explore forward-looking guidance, the results have been minimal. Since the economic bubble burst in the 1990s, Japan's core inflation rate has been negative for a long time. Even if it turns slightly positive, it has hovered around 0.5% for most of the period, basically not getting rid of the economic and price downturn.
On the contrary, the practice of forward guidance in the United States has been relatively successful.
The Fed's use of forward guidance began in 2003. After the Internet bubble burst, the U.S. economic recovery was weak and the unemployment rate was high. After the Federal Reserve lowered the federal interest rate to 1%, it announced that "the Committee believes that loose monetary policy will be maintained for a long period of time." This is the beginning of forward guidance.
After the financial crisis broke out in 2008, the Federal Reserve lowered federal funds to 0-0.25% and announced that it would maintain an extremely low level for a long time. The wording was still vague. From August 2011 to September 2012, the Federal Reserve used time guidance three times in a row to specify the minimum time for maintaining low interest rate policies. For example, in September 2012, the Federal Reserve announced that federal interest rates would remain at extremely low levels until at least mid-2015.
In December 2012, the Fed further clarified the content of its forward guidance, stating that it would maintain a low interest rate policy when at least three conditions are met: (1) the unemployment rate is higher than 6.5%; (2) inflation expectations in the next one to two years are not More than 2.5%; (3) Long-term inflation expectations remain stable.
As the U.S. economy gradually improved, in December 2015, the Federal Reserve announced a 25 basis point interest rate hike, starting a new round of interest rate hike cycles. By December 2018, the Federal Reserve raised the federal funds rate to 2.5%.
The evolution of the Federal Reserve's forward guidance
Judging from the unemployment and inflation data in the United States, the unemployment rate in the United States climbed from 5.4% in January 2008 to a peak of 10.6% in January 2010, and then began to decline all the way to In December 2015, when the Federal Reserve started raising interest rates, this value had dropped to 4.8%. The inflation level in the United States dropped from 4.28% in January 2008 to the lowest point of -2.10% in July 2009, and then slowly recovered, reaching 2.29% in December 2019. It should be said that the Federal Reserve's quantitative easing monetary policy and forward guidance have effectively stabilized and guided market expectations, promoting the recovery of the US economy, the recovery of the overall price level, and the decline of the unemployment rate.
Although both have adopted forward-looking guidance, the policy effects of the United States and Japan are far different. In summary, there are three main reasons for :
First, Japan’s deflationary stickiness expectations. Ito and Mishkin (2004) believe that the price of deflation is very high, and long-term deflation makes it more difficult to get rid of it. This is the case in Japan. After the bubble burst in the early 1990s, because the Japanese government did not realize the seriousness of the problem, it was not until 1999 that it began to introduce a looser monetary policy.However, long-term deflation has caused businesses and residents to lose confidence, forming sticky expectations of deflation, and missing the best opportunity to respond to the crisis.
In contrast, in the United States, inflation remained at around 2% before the bubble burst. After the bubble burst, the Federal Reserve promptly introduced loose monetary policies and did not form expectations of deflationary stickiness.
Second, the Bank of Japan’s words and deeds are inconsistent. Many scholars believe that forward-looking guidance works through signaling channels, and there is a risk of "dynamic inconsistency." If the government's words and deeds are inconsistent and it breaks its promises, the policy effect will be greatly reduced or even ineffective. Japan made this mistake. In February 1999, the Bank of Japan implemented zero interest rates and promised that the policy would continue until the core CPI growth rate became positive. However, the economic situation did not improve after a period of time. In the spring of 2000, the Japanese economy began to show signs of recovery. On August 11 of the same year, the Bank of Japan canceled the zero interest rate policy and raised the lending rate to 0.25%. However, Japan's domestic inflation rate is still negative at this time, and there is no sign of the end of deflation. Obviously, the Bank of Japan has not fulfilled its policy commitments and its credibility has been damaged.
Third, Japan still has many policies that are obviously uncoordinated. For example, in 2001, in order to alleviate financial difficulties, the Koizumi cabinet decided to adopt austerity fiscal policies and significantly reduce public expenditures. The tightening fiscal policy has seriously impacted market expectations and weakened the effect of quantitative easing monetary policy.
The US government has maintained the stability and continuity of its expectation management policy, effectively guiding market expectations. On the one hand, the Federal Reserve maintains its quantitative easing monetary policy unswervingly; on the other hand, fiscal policy and monetary policy coordinate and advance steadily to create a good environment for the implementation of expected management policies. In February 2008, the U.S. government enacted an economic stimulus bill with a tax cut of US$168 billion, and subsequently introduced a series of proactive fiscal policy measures.
In addition, we have to admit that forward-looking guidance is difficult to solve the deeper problems of the Japanese economy. After the bursting of the economic bubble, Japan's domestic economic structure problems have persisted and reform has been difficult. As a result, people's confidence in economic recovery is extremely fragile, and it is difficult for expected management policies to be effectively implemented and effective.
Shinichi Fukuda, a professor at the University of Tokyo, believes that if the economy suffers a major negative impact, even if the impact has disappeared, its impact on the economy will continue to exist, which is the "hysteresis effect." During the financial crisis, many Japanese companies downsized or exited the market. These companies include not only "zombie companies" but also companies that can earn normal profits. Even if the financial system returned to normal in the early 21st century, companies that could have made profits were unable to return to their original state and could only maintain small-scale business activities.
Former Bank of Japan board member Sayuri Shirai Shirai pointed out that Japan's long-term inflation deflation actually reflects the pessimism of businesses and people about the economy and future income. The long-term appreciation of the yen, the reduction of the total domestic population, the acceleration of aging, and the slow pace of structural reforms have led to the unwillingness of businesses to Actively engaged in fixed investment and innovation activities, and following deflation-oriented pricing behavior, financial institutions are increasingly accustomed to deflation-oriented investment strategies and are shifting investments from risky assets to safer assets. The above problems and contradictions are all deep-seated reasons, and it will be difficult to reverse the policy by relying solely on expectations in the short term.
The Federal Reserve's greater success is also inseparable from the strong advantage of the US dollar as an international currency. The United States can rely on a large-scale issuance of U.S. dollars to inject a large amount of liquidity into the market, allowing U.S. dollars to flow to other countries and regions, diluting its external debt burden through U.S. dollar depreciation, and reducing the pressure on fiscal expansion policies. Since a large amount of over-issuance of US dollars does not create inflationary pressure, the Federal Reserve's macro-control policy based on expectation management even has unrestricted space. The Japanese yen does not have such a function, and the Bank of Japan's expectations management policy is greatly restricted in terms of conditions, means, and space.
4. Controversy over forward guidance
In traditional monetary policy theory, monetary policy is mainly transmitted through channels such as interest rates, asset prices and credit. Forward guidance serves as a signaling channel and broadens the toolbox for monetary policy transmission. However, judging from the actual experience of Japan and the United States, the actual effect of this tool is also controversial.
At present, the Fed's "forward guidance" tool has gradually developed from a qualitative approach in the past to a quantitative approach. In the past, after the monthly monetary policy meeting, the Federal Reserve would release the direction of future monetary policy to the market in a communiqué or press conference or on the Federal Reserve's official website. Now, the Federal Reserve will publish an dot plot in the last month of each quarter (i.e. March, June, September, and December). The dot plot shows the Fed members' predictions for interest rates in the next few years and long-term.
After the interest rate decision meeting in July this year, Federal Reserve Chairman Jerome Powell said in his speech that the Federal Reserve will make decisions on monetary policy one by one at each interest rate meeting and avoid issuing specific guidance. It will provide specific guidance for the September meeting and will pay attention to all data before the September meeting. There will be a need to remain flexible and efforts will be made to avoid increasing uncertainty.
Obviously, this Fed has given up on "forward guidance."
Ben Emons, global macro strategist at Medley Global Advisors LLC, has a similar view. He said: "Given all the inflation uncertainties, the Fed cannot give specific forward guidance. Powell must leave himself some options."
Lagarde officially announced the suspension of publication as early as mid-July. Forward guidance for future actions. Not providing any form of forward guidance would allow ECB policymakers to be "more nimble," she said.
Previously, Zhou Xiaochuan, former governor of the People's Bank of China , once pointed out that the central bank does have a clear and strong desire to continuously improve communication with the public and the market, but good communication is not easy. Uncertainty exists objectively in the market and cannot be eliminated with verbal reassurance. The central bank is neither God nor a magician, and it is impossible to erase all uncertainty issues. So central banks sometimes say: "Sorry, we have to wait for new data to come in."
Regarding the effectiveness of forward-looking guidance, Zhou Xiaochuan believes that three issues need to be considered: First, in terms of guidance to the market, is the central bank's talent and information grasp better than the market? Is it better than the market in terms of the theoretical basis for guiding the market and the prediction model ? The second is the relationship between forward guidance and traditional monetary policy tools. When there is no room for tools such as interest rates and open market operations, the only option is to talk about the future. Third, judging from international experience, various disputes cannot be avoided sometimes, and even within the central bank there are sometimes disagreements. In this case, the signals conveyed by the forward guidance cannot help the market and will not reduce the market's concerns.
In fact, factors such as the independence of central banks of various countries, the credibility and transparency of monetary policies, the sensitivity of market entities to interest rates, and whether the market can correctly understand the intentions of central banks will affect the actual effect of forward-looking guidance.
In addition, as can be seen from the previous discussion, forward guidance is generally used in conjunction with quantitative easing policies when the economy is generally sluggish and inflation is low to stimulate economic recovery, guide market trends, and stabilize public expectations.
But the current situation is exactly the opposite. On the one hand, inflation in European and American countries is at a high level, and European and American central banks need to adopt tightening policies to control inflation; on the other hand, the current global economy is weak, and rapid interest rate increases by European and American central banks are likely to lead to The economy is in recession. However, if the path of interest rate hikes is changed in order to alleviate the economic recession, this kind of "inconsistency between words and deeds and breach of promises" will damage the credibility of the central bank. From this point of view, it is reasonable for to announce "abandonment" of this promising forward-looking guidance under the current circumstances.█
References
1. Blinder A.S.et al.Central Bank Communication and Monetary Policy: A Survey of Theory and evidence2. Eggertsson, G. and M. Woodford: “The Zero Bound on Interest Rates and Optimal Monetary Policy”
3、Krugman, P., K. Dominquez and K. Rogoff: “It’s Baaack: Japan’s Slump snd the Return of the Liquidity Trap”
4. Governor Zhou Xiaochuan accepted an exclusive interview with Caixin Weekly,
http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/3016856/index.html
5. Yin Ji 16, Kuang Keke, Zhang Ming, Forward-looking guidance on monetary policy: implementation principles, main types, international experience and its implications for China
7, Guo Kesha, Shen Shaochuan, my country's "Ten A perspective on good expectation management during the Fourth Five-Year Plan period—Comparison and Enlightenment of Expectation Management Policies between Japan and the United States
