Forward guidance and heterogeneous beliefs

BIS Working Papers  |  No 750  | 
03 October 2018



Can central banks stimulate economic activity when they cannot cut short-term interest rates any further? This is particularly relevant when rates are close to zero and cannot fall further, for example in Japan since 2000, the United States from 2008 to 2015 and the euro area since 2013. Might central bank communication on future interest rates, a policy known as forward guidance, stimulate demand and eventually inflation? In particular, how has the private sector interpreted the US Federal Reserve's pledge not to increase rates before a pre-announced ("fixed") date?


We analyse the impact of the Fed's fixed-date forward guidance. In August 2011, the Fed initially announced it would not raise rates before mid-2013. In 2012, the Fed twice extended the horizon for keeping rates near zero and said it would not increase rates before 2015. The work contributes to the debate about the effectiveness of forward guidance policies and, in particular, the risks that they will not necessarily result in a looser monetary policy stance.


The Fed's fixed-date forward guidance helped to coordinate expectations of future interest rates. All professional forecasters reached an unprecedented consensus that future interest rates would stay close to zero for two years. But their expectations for future economic growth varied. One group of "pessimist" forecasters saw the Fed announcements as signalling a deteriorating outlook. Another group, the "optimists", saw the guidance as a promise of further monetary stimulus. Thus, they lifted their forecasts for growth and inflation while lowering their expectations for future interest rate rises. Since only "optimists" would react by increasing spending, our findings suggest forward guidance is most effective when observers see it as a promise of future stimulus. This supports the argument that, unless central banks can make this more explicit when explaining their policy frameworks, forward guidance may fail to stimulate economic growth. In fact, it may even deter it.



Central banks' announcements that rates are expected to remain low could signal either a weak macroeconomic outlook, which would slow expenditure, or a more accommodative stance, which may stimulate economic activity. We use the Survey of Professional Forecasters to show that, when the Fed gave guidance between Q3 2011 and Q4 2012, these two interpretations co-existed despite a consensus on low expected rates. We rationalise these facts in a New-Keynesian model where heterogeneous beliefs introduce a trade-off in forward guidance policy: leveraging on the optimism of those who believe in monetary easing comes at the cost of inducing excessive pessimism in non-believers.

JEL classification: E31, E52, E65

Keywords: signaling channel, disagreement, optimal policy, zero lower bound, survey forecasts