Primary navigation:

QFINANCE Quick Links
QFINANCE Reference

Home > Blogs > Moorad Choudhry > Forward Guidance Mark II: further stretching logic

Forward Guidance Mark II: further stretching logic

Forward Guidance Mark II: further stretching logic Moorad Choudhry
Facebook LinkedIn Twitter

Forecasting the future is an undertaking fraught with risk, mainly because it is difficult, if not impossible, to do with any degree of accuracy or consistency. Astrologers and palm readers are familiar with this problem in their daily line of work.

It stands to reason that linking one’s policy and actions to forecasting is, by the same token, fraught with risk. That isn’t stopping central banks from doing it though.

Last year the Bank of England kicked off its “forward guidance” with an explicit linkage, certain caveats included, of the base rate to the level of unemployment. Taking its logic from a similar policy at the US Federal Reserve, the trigger point was set at 7%. This connection was unfortunate because, in reality, there is no direct link between unemployment, which is impacted by many factors, and the base rate. But no matter. The Bank’s forecast at the time had unemployment not reaching this level until 2016.

So the message was: “rates are unlikely to rise until 2016 at the earliest”.

Unfortunately for the Bank, the level of unemployment fell much quicker and at the last count was at 7.1%. So, the Bank has now gone for another connection. Rates will not rise until “spare capacity” is no longer evident in the economy. This is when GDP rises and brings with it inflation. Before then, no rise. Now, funnily enough, the Bank estimates that this spare capacity will be eliminated in about “3 years”, taking us to the end of… 2016!

That’s very handy. Never mind the fact that things like “excess capacity” and “output gap” are very difficult to measure, let alone forecast - the question that Forward Guidance Mark II brings to mind is: what if the excess capacity starts to disappear much quicker?

The other more direct question is: what’s the point of linking rates to a trigger if, when the trigger arrives we decide to move it? I simply don’t get this. If the Bank doesn’t want to raise rates until 2016 at the earliest, why not simply state this?

It seems to be: “we want to keep some freedom of action, but we want to remove uncertainty. So, let’s pick a trigger that seems far enough away, and that will remove uncertainty. But if the trigger gets closer, lets change to another trigger.”

What's wrong with this picture?

Facebook LinkedIn Twitter

Tags: Bank of England , base rate , central bank , excess capacity , forward guidance , GDP , inflation , interest rate , output gap , trigger , unemployment , US Federal Reserve
  • Bookmark and Share
  • Mail to a friend


or register to post your comments.

Back to QFINANCE Blogs

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • RSS
  • Bookmark and Share

Blog Contributors