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Working Paper

Understanding the Aspects of Federal Reserve Forward Guidance

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This paper studies the effects of Federal Open Market Committee (FOMC) forward guidance language. I estimate two policy surprises at FOMC meetings: a change in the current federal funds rate and an orthogonal change in the expected path of the federal funds rate. From February 2000 to June 2003, the FOMC only gave forward guidance about risks to the economic outlook, and a surprise increase in the expected federal funds rate path had expansionary effects. This is consistent with models of central bank information effects, where a positive economic outlook causes private agents to revise up their expectations for the economy. From August 2003 to May 2006, the FOMC also gave forward guidance about policy inclinations, and a surprise increase in the federal funds rate path had contractionary effects. These results are consistent with standard macroeconomic models of forward guidance. Overall, the effects of forward guidance depend on the FOMC’s choice to use one or both of the economic-outlook and policy-inclination aspects of forward guidance.
Topics
Bank policy and regulation
11.07.2018ISSN 2573-7953 WP 18-15DOI 10.26509/frbc-wp-201815
Keywords central bank communication, event study, federal funds futures, information effects, monetary policy
JEL Classification Codes E43, E44, E52, E58, G14

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Lunsford, Kurt G. 2018. “Understanding the Aspects of Federal Reserve Forward Guidance.” Federal Reserve Bank of Cleveland, Working Paper No. 18-15. https://doi.org/10.26509/frbc-wp-201815