Rethinking forward guidance?
Arguably, no central banker in the world has been bolder and more aggressive about quantitative easing than Japan’s Haruhiko Kuroda. Yet his $700 billion in bond purchases every month have failed to generate the 2 percent inflation targeted by the Bank of Japan: New figures released on Friday showed that core consumer price inflation had once again flattened to zero in February.
This raises the obvious question: Has monetary policy become ineffective? Several factors are driving prices down in Japan - from lower energy costs, to anemic wage growth and a fast-aging population, to the lack of structural reform and tenacity of a “deflationary mindset” that’s been 20 years in the making. Here’s another possibility, though: Central bankers may simply have become too open about their thinking.
That’s what the Reserve Bank of New Zealand, for one, seems to think. In Wellington, Gov. Graeme Wheeler seems to be reconsidering what central bankers call “forward guidance” - the practice of providing explicit, long-term forecasts for where rates are headed. The idea is to give markets strong hints, well in advance, what the central bank’s next move will be. By doing so, policy makers hope to avoid excessive volatility, but also to influence long-term rates either to stimulate or restrain economic activity. Kuroda has long been a proponent of the strategy, rarely missing an opportunity to conduct “open-mouth operations” illuminating his thinking. The Fed adopted the policy in 2012 and the European Central Bank has dabbled with it under Mario Draghi.
New Zealand’s central bank helped pioneer the practice in 1997, when it began announcing specific forecasts for 90-day bank bills. Markets knew where monetary policy was headed, limiting speculation and destabilizing gyrations in bond yields. But this month, Wheeler chopped one-year-off forecasts for 90-day bank bills.
As my Bloomberg colleague Matthew Brockett reports, the missing directive would probably have hinted at a tightening in 2017. Even as Australia slows, China hits a wall and Japan underwhelms, New Zealand is zooming along at an enviable 3.5 percent pace of growth. In the short run, Wheeler is giving himself greater wiggle room should events change.
In the longer run, though, he may be testing whether more mystery might enliven policy. There’s an argument, as ECB Executive Board member Benoit Coeure warned in September 2013, that if not managed, “forward guidance could have a contradictory, rather than an expansionary, effect on economic sentiment.” His argument: Offering such hints might be interpreted as a sign that the central bank is indirectly disclosing negative information about risks to the economic outlook. “In this case,” he said, “private agents may infer from the forward guidance statement that the recovery may be slower or deflationary pressures stronger than widely anticipated,” denting growth outlook.
A December 2012 St. Louis Fed study offers additional cautions. “Overall, the statistical analysis provides weak evidence that forward guidance increased the ability of market participants to forecast future short-term yields and no evidence of increased predictability of long-term yields,” wrote economists Clemens Kool and Daniel Thornton. “Given the generally modest improvement in forecasting ability relative to the non-forward-guidance country benchmark … it’s difficult to see how forward guidance could significantly increase these central banks’ ability to control long-term yields.” In other words, the amount of influence central bankers gain by the practice isn’t worth the bother.
Such concerns may help explain why we’re seeing a rash of unexpected rate actions that harken back to Paul Volcker’s 1979-1987 term as Federal Reserve chairman, before forward guidance was introduced. “We’ve certainly had a trend this year where central banks are less market friendly, with surprise moves from a number of them,” says investment strategist Simon Grose-Hodge of LGT Group. By catching markets off-guard as they did in the 1970s, 1980s and 1990s, central banks benefit from a so-called headline effect that shocks markets into submission.
In India, Gov. Raghuram Rajan has deliberately surprised markets with rate cuts twice this year. Bank of Korea Gov. Lee Ju-yeol discombobulated traders with an unexpected March 12 cut. Ditto for Indonesia, Singapore, Thailand and China. Even the world’s biggest central banks may be telegraphing less. The Fed, for example, appears to be diluting its forward guidance, as does the Bank of England.
Caveats abound, of course. In Wellington, Wheeler may just be responding to the disorienting environment in which central banks are operating - rates at, or below, zero in many developed nations, the rising influence of emerging economies like China, fiscal balance sheets loaded to the hilt, governments relying on central banks to do their jobs for them. Given all that, who knows if the ECB’s next move should be to cut or boost short-term rates? Also, the unprecedented waves of liquidity sloshing around the globe - not the tactics of policy makers - may be dampening the effect of any individual rate cuts. Being more mysterious might not help Kuroda bring inflation back to Japan. Still, it can’t hurt to try.
*The author is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region.
by William Pesek