The Forward Guidance Trap

No 23-E-06, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: This paper examines the policy experience of the Fed, ECB and 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 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: 2023-10
New Economics Papers: this item is included in nep-ban, nep-mac and nep-mon
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Related works:
Working Paper: The forward guidance trap (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:23-e-06

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