Forward Guidance and Expectation Formation: A Narrative Approach
Forward guidance is a central bank statement that provides direct information about the probable state of monetary policy in the future. Its purpose is to influence interest rate expectations. But how exactly does it do so?
To study this issue, I construct central bank data that includes forward guidance and its attributes, central bank projections and quantitative easing, which I then combine with survey data.
I find that, in response to a change in forward guidance, forecasters revise their interest rate forecasts in the intended direction by 5 basis points (0.05 percent) on average. The effect is not attributable to central bank information effects. Instead, when forming rate expectations, forecasters place full weight on their own inflation and growth forecasts and zero weight on those of the central bank. I also provide evidence that Odyssean (commitment-based) forward guidance is exceedingly rare but can strongly amplify forward guidance.