The Forward Guidance Trap

Athanasios Orphanides
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Athanasios Orphanides: Professor of the Practice of Global Economics and Management at the MIT Sloan Schoolof Management (E-mail: athanasios.orphanides@mit.edu)

Monetary and Economic Studies, 2024, vol. 42, 71-92

Abstract: This paper examines the policy experience of the Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of Japan (BOJ) during and after the Covid-19 pandemic and draws lessons for monetary policy strategy and its communication. All three central banks provided appropriate accommodation during the pandemic but two failed to unwind this accommodation in a timely manner. The Fed and the ECB guided real interest rates to inappropriately negative levels as the economy recovered from the pandemic, fueling high inflation. The policy error can be traced to decisions regarding forward guidance on policy rates that delayed lift-off while the two central banks continued to expand their balance sheets. The Fed and the ECB fell into the forward guidance trap. This could have been avoided if policy were guided by a forward-looking rule that properly adjusted the nominal interest rate with the evolution of the inflation outlook.

Keywords: Monetary policy strategy; Forward guidance; Policy rules (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imemes:v:42:y:2024:p:71-92

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