Forward Guidance

Forward guidance is a tool used by a central bank to exercise its power in monetary policy in order to influence, with their own forecasts, market expectations of future levels of interest rates. With forward guidance, central banks promise to keep interest rates lower for a longer period than signaled by traditional reaction function. Central banks try to guide expectations of market participants about the future path of policy. The strategy can be implemented in an explicit way, expressed through communication of forecasts and future intentions, sometimes known as Odyssean forward guidance. Implied forward guidance also exists, sometimes referred to as Delphic forward guidance. It is a softer and less-binding version of forward guidance to achieve similar effects. Among the main central banks, Delphic forward guidance dominates, although there are a couple of exceptions such as the US Federal Reserve, which makes quite specific but still conditional statements, and the Bank of Japan.