Miles, D. (2014) “‘Mensch tracht, und Gott lacht’ – what’s the best guidance on monetary policy?“, VoxEU Organisation, 22 October.
Many central banks embrace forward guidance by announcing expected interest rate paths. But how likely it is that actual rates will be close to expected ones? This column argues that quantifying such uncertainty poses great difficulties. Precise probability statements in a world of uncertainty (not just risk) can be misleading. It might be better to rely on qualitative guidance such as: “Interest rate rises will probably be gradual and likely to be to a level below the old normal”.
“Mensch tracht, und Gott lacht” is a Yiddish proverb – men plan and God laughs. Woody Allen puts the same thought this way: “If you want to make God laugh tell him about your plans”. Some people might see these words as a fitting epitaph for forward guidance on monetary policy. The Bank of England has certainly faced a good deal of criticism for the guidance that it has recently been giving, as has the Federal Reserve in the US. In both cases the nature of the guidance has evolved, though I think it is rather harsh to assume that God has been laughing at how things have gone; anyway it is hard to know. Yet there is a real question here that is worth thinking about: What is the most useful way for a central bank to provide information about the way in which it will set monetary policy?
Consider a spectrum of choices a central bank might face about what it says about its future policies. At the minimalist end of the spectrum (which we might associate with Montagu Norman)1 is just a statement that the central bank will continue to do what it sees as most appropriate over time. At the other end of the spectrum is an explicit commitment that policy will be set in a specific way at each point in the future – not just a rule that might be followed but a commitment to a particular policy setting. Between these two are a great many intermediate points. Nearer the vague end is a statement of the goal of policy (e.g. an inflation target) but little beyond that. Further along again might be an assessment of how the policy set by the central bank might evolve for different outcomes of some of the main forces driving the economy. That would tell you something about the central bank’s reaction function. Or the central bank could give an explicit forecast of what it thinks its most likely future policy will be.
I think it is helpful to think about forward guidance as being a choice about which point to settle on along the spectrum I have described.
Related posts:
- Claeys, G. (2014) “The (not so) Unconventional Monetary Policy of the European Central Bank since 2008“, Policy Department A for the Monetary Dialogue discussions in the Economic and Monetary Affairs Committee (ECON) of the European Parliament, 09 July.
- P.W. (2014) “The case against maxing out monetary policy“, Free Exchange–Economics, The Economist, 29 June.
- Wren-Lewis, S. (2014) “Real wages, monetary policy and innovation“, Mainly Macro Blog, 22 June.