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Forward Guidance Effectiveness, Now vs. Then

Summary:
I’m teaching unconventional monetary policy in Financial Systems course. Here’s some interesting graphs (not altogether new), relating to forward guidance effectiveness. Figure 1: Three month Treasury yield (blue), and Survey of Professional Forecasters average forecasts as of Q3 survey (red +).  Three month yield is from secondary market. Blue dashed line implementation of forward guidance on Fed funds rate. Source: FRED, Philadelphia Fed SPF. Since the forecasts pertain to the short rate, here the forecasters are essentially predicting Fed behavior. Notice that after announcing explicit forward guidance (January 25, 2012), expectations of future short rates declined. In the most recent episode, the response of expectations has been more definitive. Figure 2: Three month Treasury

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I’m teaching unconventional monetary policy in Financial Systems course. Here’s some interesting graphs (not altogether new), relating to forward guidance effectiveness.

Forward Guidance Effectiveness, Now vs. Then

Figure 1: Three month Treasury yield (blue), and Survey of Professional Forecasters average forecasts as of Q3 survey (red +).  Three month yield is from secondary market. Blue dashed line implementation of forward guidance on Fed funds rate. Source: FRED, Philadelphia Fed SPF.

Since the forecasts pertain to the short rate, here the forecasters are essentially predicting Fed behavior. Notice that after announcing explicit forward guidance (January 25, 2012), expectations of future short rates declined.

In the most recent episode, the response of expectations has been more definitive.

Forward Guidance Effectiveness, Now vs. Then

Figure 2: Three month Treasury yield (blue), and Survey of Professional Forecasters average forecasts as of Q3 survey (red +), as of Q1 survey (teal +).  Three month yield is from secondary market. Blue dashed line implementation of forward guidance on Fed funds rate. Source: FRED, Philadelphia Fed SPF.

Notice that the 2020Q2 forecasted interest rate (as of 2020Q1) seems inordinately high; but the survey for Q1 was made in the last week of January/first week of February – much before news of Covid-19 had made much impact in the US (and much before the lockdown in mid-March 2020).

As of Q3 forecasts (made in late July/early August), expectations were for an extended period of near-zero rates.

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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