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8/9/2019 Goldman Sachs - A Guide to Guidance
1/17
The Goldman Sachs Group, Inc. Goldman Sachs Global Investment Research
A Guide to Guidance
From the editor:With the recent adoption of explicit forward guidance as a stimulative
policy tool by the major European central banks, virtually every major central bank is
now using the tool in some form. The potential benefits and dangers of such policies
have therefore become Top of Mind. We ask Professor Michael Woodford widely
regarded as one of the leading monetary economists whether the greater use of
guidance is a good thing. His answer: YES, but the form of the guidance matters. We
then lay out our take on why some central banks remain hesitant to fully embrace thepolicy (concerns about inflation as well as tying their hands in an uncertain world), if
softer guidance can still be effective (somewhat, according to the Scandi experience),
why disconnects (Sep 18 taper NOT!) still happen (things change, making it hard to
sometimes follow through), whats better: asset purchases or forward guidance
(increasingly the latter), and what the market seems to prefer (deeds over words).
Source: wordle.com
Inside
Interview with Michael Woodford
Professor, Columbia University
4
The taper head-fake and whats nextKris Dawsey, GS US Economics
6
Forward (mis)guidance?Huw Pill, GS European Economics
8
Can words really equal deeds?
Robin Brooks, GS Global Markets
10
Efficacy of QE versus FG
Jari Stehn, GS US Economics
12
Lessons from forward guidance pioneers
Lasse Holboell Nielsen, GS European Economics
13
The issues raised by recent
policy experience concern the
means to steer interest rate
expectations, rather than the
desirability of doing so. And the
adoption of more explicit
communication to steer rates
remains justifiably controversial.
Huw Pill
Its a mistake to view asset
purchases and forward guidance
as two alternative means to
providing further stimulus, so that
we can avoid having to say more
about future policy if instead we
are acting to make additional
asset purchases.
Michael Woodford
[In terms of implications for
rates]the jury is still out on how
well forward guidance works.
What is clear, though, is that
markets prefer deeds to
words.
Robin Brooks
Economics, Commodities and Strategy Research
Top of MindOctober 31, 2013 Issue 18
Editor: Allison Nathan | allison.nathan@gs.com | +1 (212) 357-7504 | Goldman, Sachs & Co.ECS Executive Committee: Jeffrey Currie | Jan Hatzius | Kathy Matsui | Timothy Moe | Peter Oppenheimer | Dominic Wilson
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification,see the end of the text. Other important disclosures follow the Reg AC certification, or go towww.gs.com/research/hedge.html.
8/9/2019 Goldman Sachs - A Guide to Guidance
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Goldman Sachs Global Investment Research 2
Top of Mind Issue 18
US Japan
Latest GS proprietary datapoints/major changes in views
The cumulative weakness in the labor market over the last
three months has led us to push back our expectations on the
announcement of tapering to the March 2014 FOMC meeting.
We still expect growth to pick up from 1.6% in 2013E to 2.9%
in 2014E; the ISM indices are in strongly expansionary territory.
Datapoints/trends were focused on
The potential for more disruption around fiscal deadlines: (1)
December 13: targeted conclusion of House-Senate budget
negotiation, (2), January 15: expiration of spending authority, (3)
Mid-March: likely debt limit deadline.
Latest GS proprietary datapoints/major changes in views
We revised our $/JPY forecasts slightly lower on October 10
given a lack of near-term catalysts for a weaker Yen.
Datapoints/trends were focused on
The national CPI that excludes fresh foods and energy pulling
out of negative territory in September for the first time since
December 2008.
A rise in household current conditions sentiment in September
for the first time in six months on favorable auto sales and a pre-
tax-hike rush in demand.
US manufacturing on the riseUS ISM manufacturing index
Japanese non-energy prices (finally) on the riseCore-core CPI (excludes fresh foods and energy), yoy %chg
Source: ISM, Goldman Sachs Global Investment Research. Source: MIC.
Euro Area (EA) Emerging Markets (EM)
Latest GS proprietary datapoints/major changes in views
We now expect the ECB to offer a longer-maturity LTRO, which
we believe would be constructive for the banking sector and
the economy during 1H14 rather than by the end of the year.
Datapoints/trends were focused on
The euro has appreciated around 1% since the ECBs October
meeting, which adds to the downside risks to growth and
increases the chance of a rate cut, but we do not expect action
beyond a potential mention of concern at the Nov meeting.
Spain exiting recession, leaving GDP 7.4% below its 2008 peak.
Latest GS proprietary datapoints/major changes in views
China growth tracking around 9% as measured by our Current
Activity Indicator (CAI).
Datapoints/trends were focused on
Rising concerns about another liquidity squeeze in China.
Continued declines in Brazilian industrial sector confidence to
the lowest level since July 2009 despite recent depreciation in
the BRL; Mexico has also converged to the sluggish growth
path of Brazil, but is better positioned to provide stimulus
(further rates cuts) given its much more benign inflation.
Spain (finally) growing againSpain GDP, %
Inflation deviation (Mexico vs. Brazil)% of CPI above inflation-targeting-midpoint, 3mma
Source: INE. Source: Haver Analytics, Goldman Sachs Global Investment Research.
48
50
52
54
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Jan May Sep Jan May Sep Jan May Sep Jan May Sep
2010 2011 2012 2013 -1.5
-1.0
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0.0
0.5
1.0
11/1 11/7 12/1 12/7 13/1 13/7
Energy contribution
Non-energy contribution
National core CPI
Sep
13/9
-2.0
-1.5
-1.0
-0.5
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0.5
1.0
1.5
2.0
-10
-8
-6
-4
-2
0
2
4
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10
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
qoq (rhs) yoy (lhs)
3Q
20
30
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60
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80
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13
BRA MEX
Macro news and viewsWe provide a brief snapshot on the most important economies for the global markets
8/9/2019 Goldman Sachs - A Guide to Guidance
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Goldman Sachs Global Investment Research 3
Top of Mind Issue 18
As we approach the five-year anniversary of the US Federal
Reserve Board lowering US policy rates to their effective zero-
bound in the midst of the Global Financial Crisis, central banks
across the developed market economies faced with generally
improving but still-anemic growth continue to look to
unconventional policy tools to further stimulate their economies.
The use of explicit forward guidance is one of these tools, which
has been used by the Bank of Japan and other central banks for
some time and has been a crucial part of the Feds post-crisis
policy strategy, evolving from vague qualitative guidance in
December 2008 to more explicit calendar guidance in August
2011 (which committed to low rates until at least a certain date),
and to threshold guidance in December 2012, (which committed
to low rates until specific economic conditions were met).
In recent months, both the European Central Bank (ECB) and the
Bank of England (BOE) also began experimenting with explicit
forward guidance as a stimulative policy tool, marking a not entirely
new but important shift in approach given these central bankssubstantial reluctance to adopt such policies in the past. With
various forms of forward guidance now being implemented by
virtually every major central bank, the potential benefits and
dangers of such policies have become Top of Mind.
We interview Michael Woodford, a professor at Columbia
University whose seminal paper presented at the Jackson Hole
central bank conference in August 2012 was thought to
substantially influence the Feds September 2012 adoption of QE3.
We ask if the greater use of forward guidance is a good thing (yes,
it can reduce misinterpretations of policy and enhance its
stimulative effect), if threshold guidance is better than
calendar guidance (yes, because it is ultimately more credible), if
the softer version of forward guidance adopted by the Europeancentral banks will negate its effectiveness (yes, to some degree),
how he thinks about asset purchases versus forward guidance (its
a mistake to think of asset purchases as a way to avoid having to
talk about future policy intentions), and why the market and the
Fed have seemed so disconnected at various points this year
despite substantial attempts by the Fed to communicate more
clearly (there were mistakes in communication, but that does not
mean the situation would have been better if the Fed had instead
kept its mouth shut, especially in such unprecedented times.)
We then provide our take on these questions. Our chief European
economist, Huw Pill, looks at why some central banks remain
reluctant to embrace forward guidance especially on the
European side of the pond and thus have adopted softer forms of
it. But Lasse Holboell Nielsen, also of our European economics
team, uses the Scandi experience with explicit but conservative
forward guidance to suggest that softer forms can still be effective
in shaping policy expectations, with lessons for the ECB.
Jari Stehn of our US economics team then looks at the evolution of
the use of asset purchases versus forward guidance, with external
and our own analysis increasingly favoring forward guidance as a
policy tool. And Kris Dawsey, also of our US economics team, drillsdown into the disconnect between the market and the Fed around
the September 18 FOMC meeting when the market was clearly
surprised by the Feds decision not to taper concluding that
things had changed sufficiently heading into the meeting to give
the Fed pause in following through with the expectations it had
largely created for itself.
Finally, Robin Brooks of our global markets team looks at market
implications of these policies, with past experience in the US and
Canada suggesting that deeds still speak louder than words.
Allison Nathan, Editor
Email: Allison.Nathan@gs.com
Tel: 212-357-7504Goldman, Sachs & Co.
The evolution of central bank communication/transparency
Source: Goldman Sachs Global Investment Research.
A Guide to Guidance
Central
bank policy
intentions
shrouded
in secrecy
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
BOE, Feb-93
Publishes first
Inflation
Report
Fed, Mar-93
Begins
releasing
minutes of
FOMC
meetings
(with 68
week lag)
Fed, Nov-93
Begins
releasing
transcripts
of FOMC
meetings
(with 5 year
lag)
Fed, Feb-94
Begins
explicitly
announcing
changes in
federal funds
rate target
RBZ, Jun-97
Begins
announcing its
forecast of
future short-
term interest
rates
BOE May-97
BOE granted full
independence
and MPC
established
BOE, Oct-98
BOE MPC
expedites release
of Minutes from
5 weeks to 2
weeks (13 days)
BOJ, Jan-98
Monetary
policy
meeting
begins on a
monthly
scheduled
basis (ad-
hoc before)
ECB, Jan-99
Begins conducting
monetary policy,
which includes
some aspect of
forward guidance
in its "intention to
maintain a 3%
MRO rate for the
foreseeable future"
Fed, Jan-00
Commits to
publishing a
statement
after every
FOMC
meeting;
Replaces
tilt with
statement
describing
balance of
risks to
economic
outlook
intended to
cover an
interval
extending
beyond the
next FOMC
meeting
BOJ, Oct-00
Begins
publishing
report on
growth and
inflation
outlook
BOJ Mar-01
Initiates
outcome-based
guidance for its
rate policy
Fed, Mar-02
Begins
releasing
votes of
individual
Committeemembers
and
preferred
policy choice
of any
dissenters
Fed, Aug-03
Begins toissue direct
qualitative
statements
about its
future policy
inclinations
in various
verbal
formulations
BOJ, Oct-03
Makes the
conditions for an
exit from QE more
transparent,providing three
conditions that
must be satisfied
before ending QE
Fed, Feb-05
Expedites
the release
of FOMC
minutes to
make them
available
before the
subsequent
FOMC
meeting
NorgesBank,
Nov-05
Begins to regularly
release forecasts
of the future path
of their policy rate,
2-3 years ahead
BOJ, Mar-06
Introduces the
"understanding ofmedium-to-long-term
price stability" in
numerical form (0-2%);
Introduces the "two
perspectives
approach" that
considers the dual
mandate as well as an
assessment of risk
Riksbank,
Feb-07
Begins to
regularly
release
forecasts of
the future
path of their
policy rate
Central
Bank of
Iceland,
Mar-07
Begins toregularly
release
forecasts of
the future
path of their
policy rate
Fed, Nov-07
Increases the
frequency and
expands the
content and
horizon of its
publicly-
released
inflation and
economic
activity
forecasts
BOJ, Jul-08
Announces: (1)
The release of
statement
explaining their
latest
assessment of
the economic
and price
situation after
every meeting
(not just those
when interest
rates are
changed) (2)The October
semi-annual
economic and
price outlook
will release
forecasts for a
longer time
horizon
(3) Risk
balance charts
will be
published more
frequently (4)
Release of
minutes will
always be
before the
subsequent
meeting (5)
Monthly
economic
assessments
in Japanese
will bereleased the
day after the
Board meets
(English
version two
days after)
BOC, Apr-09
Initiates calendar-
based guidance,
conditional on the
inflation outlook
Fed, Apr-11
Chairman
holds first
press
conference
following a
FOMC
decision
Fed, Aug-11
Shifts to
calendar-
based
guidance
from vague
qualitativeguidance
BOJ, Feb-12
Sets inflation
"goal"
Fed, Dec-12
Replaces
calendar-based
guidance with
outcome-based
guidance
("thresholds)
BOE, Mar-13
Remit adjusted
to further
formalize
inflation/growth
flexibility; BOE
invited to
consider forward
guidance
ECB, Jul-13
Introduces
forward
guidance -
not new in
its history
but a
significant
step away
from the
mantra "we
never pre-
commit" that
Trichet
established
BOE, Aug-13Introduces
outcome-based
forward guidance
(first time it has
used forward
guidance of any
kind)
Red = Fed Purple = ECB Blue = BOJ Green = BOE Orange = Notable innovators/ others
BOJ, Apr-98
Introduction
of Bank ofJapan law
that clearly
sets out the
dual
mandate of
sustainable
growth
under price
stability
BOE, Jun-98
Bank of EnglandAct formalizes
independence
Fed, May-99
Releases a
statement
about the
FOMC
decision
even after
no change in
federal funds
rate target;
Begins
announcing
policy tilt
indicatingmost likely
future
interest rate
action
between
then and the
next FOMC
meeting
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Goldman Sachs Global Investment Research 4
Top of Mind Issue 18
Michael Woodford is the John Bates Clark Professor of Political Economy at Columbia University.
His paper Methods of Policy Accommodation at the Interest Rate Zero-Bound presented at
Jackson Hole in August 2012 was widely regarded as the seminal paper at the central bank
conference. Below he discusses the benefits of forward guidance, even if it is no panacea.The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.
Allison Nathan: Havent central banks
always tried to influence interest rate
expectations? What is so special
about forward guidance today?
Michael Woodford: No, central banks
have not tried to do things that were at
all similar to this in the past. Until quite
recently, all central banks were very
reluctant to say things in advance
about future policy decisions, and this
reluctance remains to varying degrees at
many banks. The forward guidance
adopted by the Fed and other central
banks, which tries to influence
expectations by actually saying things about policy intentions, is
therefore a new policy tool and indeed one that has become more
important given the near-exhaustion of the most traditional policy
tool adjusting policy rates as rates across the major economies
already hover around their effective lower bound.
Allison Nathan: What are the benefits of forward guidance?
Michael Woodford: If policy expectations matter and I think it is
pretty clear that they are crucial to how longer-term assets end up
getting priced then there are two kinds of advantages of explicitly
discussing future policy by the central bank. One advantage is that
it can reduce misunderstandings about policy intentions,
which, in turn, can reduce uncertainty for the central bank about
the effect of its policy on the markets. In principle, talking directly
about policy intentions would allow the use of more complex
policies, which might not otherwise be pursued for fear that they
would not be understood without explanation. The second general
type of gain from explicitly talking about future policy is to help
ensure that the policy committee itself will follow through
with its commitmentseven though it may have motives to depart
from them later on.
Both of these potential advantages are particularly clear when youreach an effective lower bound on policy rates. At that point,
convincing people that the policy rate will remain lower for
longer can help ease financial conditions today, providing
additional stimulus to the economy when traditional tools no longer
can. But talking about the intention of lower for longer is crucial
because being at this lower bound is a very unusual situation,
so there is little past experience that people can look to in
order to anticipate how the central bank is going to respond.
There is also a clear need for the central bank to commit itself in
advance in order to achieve the stimulative benefit. That is because
of course later when the stimulus has worked and the economy
is improving - the bank will have little motivation to actually keep
rates low (the so-called time inconsistency problem) unless they
committed to do so in advance. To overcome that problem, the
central bank needs to make an explicit promise that would be
difficult or embarrassing to just completely ignore later.
Allison Nathan: What are the dangers of forward guidance?
Michael Woodford: The most obvious danger, which has likely
been the main reason for central banks reluctance to talk about
future policy in the past, is the possibility that a policy
commitment that looks sensible at some earlier time turns out
to be unwise because things happen in the meantimethat the
central bank did not expect. Those costs can be reduced without
losing all of the potential benefits of forward guidance if the central
banks think carefully about what kind of commitments about future
policy should be made. It makes sense to avoid unnecessary
specificity about things that do not need to be specified too
precisely in order to achieve the desired change in expectations.For example, in the case of a commitment to keep the federal
funds rate low for longer in order to stimulate the economy today,
the central bank could make a very specific commitment about the
path of the policy rate over time. But there would be much more
likelihood of embarrassment in that case than if the bank instead
committed to keep rates low until certain economic conditions
arise, whenever that may be.
Allison Nathan: The BOE and the ECB have said that the
intention of their shift to forward guidance has been to clarify
their policies rather than to commit to lower for longer. Will
this approach negate the benefits of the guidance?
Michael Woodford: Yes, to some degree. In the case of the Bankof England, the structure of their statement with several so-called
knock-out provisions - as well as their insistence that the
statement was nothing more than a clarification of the BOEs
normal reaction function, has given people little reason to change
their prior beliefs about how soon the Bank would raise rates.
Because of this, the statement does not seem to have moved
market expectations much and in the way that the BOE thought it
should. Similarly, the ECB has taken small steps towards doing
something that you might think of as forward guidance, but has
also done so quite hesitantly; they are also inclined to deny that
they are committing themselves at all about future policy. Given
the aversion to talking about policy intentions in the past, this
hesitation is not surprising, nor is the fact that even central banksthat have decided that they should experiment with the policy do it
in a way that simultaneously denies that they would ever do it,
because it goes against their instincts. But that to some extent
defeats the purpose of the policy. Their approach is quite
different from that of the Fed, which has more clearly embraced
the policy of lower for longer.
Allison Nathan: Is the Feds shift to outcome-based or
threshold guidance from calendar guidance a good thing?
Michael Woodford: Yes, because threshold guidance is
ultimately more credible.The problem with calendar-based
guidance is that if there is a real promise to keep rates at a certain
level until a certain point in time no matter what happens, it wouldbe a pretty reckless policy. And because the policy would be
reckless, it would ultimately be hard to believe. That would be the
case unless the central bank restricted itself to a short horizon over
which there could not be many surprises. But if the horizon is too
short, the impact on future expectations would be small. So I think
Interview with Michael Woodford
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Goldman Sachs Global Investment Research 5
Top of Mind Issue 18
the possibility of making a commitment that extends far enough
into the future for it to be news about future policy that would
significantly matter to asset pricing is much more plausible if it is
based on economic conditions rather than just based on a date.
Allison Nathan: There have been several instances when the
use of forward guidance has had an opposite impact than the
central banks intended why?
Michael Woodford: The use of forward guidance is not some kind
of magical tool where the mere fact that the central bank says
something means that people will then think exactly that. A central
bank needs to give people a reason to think something new or
different about what it is going to do. A critical part of effective
policy is therefore understanding what people will think they
are learning about the banks policy.An example of this that I
talked about in my Jackson Hole paper last year was the
experience of the Swedish Riksbank in April 2009, when they cut
their policy rate to 50 basis points and accompanied this with a
statement and a published projected rate path that showed policyrates remaining at 50 basis points - the lowest level ever - until the
beginning of 2011. To the Banks surprise, market forward rate
expectations rose rather than fell following the announcement.
Why? Because the big news of the statement was not the
central banks lower projected rate path, which was in any case
just a projection and not a commitment, but that the central bank
was apparently regarding 50 basis points as a floor, which was
higher than at least some market participants had previously
guessed. That news shifted the markets most likely expected path
of the future policy rate up rather than down.
Allison Nathan: How would you explain the violence of the
bond market selloff in May/June, which came in response to a
very small change in the Fed's message?
Michael Woodford: I am inclined to think that it indicated some
mistakes in Fed communicationprior to May that led to two
possible types of misinterpretation about the Feds intentions.
First, some people may have interpreted the start of taper talk as
a signal that the Fed was trying to withdraw accommodation more
broadly, and was also preparing to start raising interest rates. That
was a surprise to the FOMC; they didn't think they were saying
anything that would suggest they were preparing to raise rates.
But they had left themselves open to that misinterpretation by
failing to explain earlier the criteria that would determine the path
of asset purchases in a way that sounded very different from the
criteria that would determine the path of interest rates. The
forward guidance about both asset purchases and interest rates
focused on labor market conditions and sounded very closely
related. I do not think that the Fed meant for the criteria to be the
same, but they failed to sufficiently explain why they would not be.
Second, there may have been a number of people who thought the
purchases were going to continue at the current rate for a lot
longer, and learned suddenly that they would not. If that was news
to people, it was again a failure of communication because I doubt
that the Fed had ever thought asset purchases would continue at
the current rate beyond 2013. Despite these failures, it would be
a mistake to conclude that the Fed should not have started
speaking about tapering when it did; the problems would not
have been avoided if the Fed had just kept its mouth shut, because
the misinterpretations would still be there. And shutting yourmouth is potentially setting you up for an even harder adjustment
later when the misinterpretations must eventually be exposed.
Allison Nathan: Why was the market so surprised by the
decision not to taper at the September FOMC?
Michael Woodford: It certainly seemed to me that during the
summer the ground was being prepared for a slowing of the rate of
purchases. As to why they did not actually do it, I think it was a
reaction to the fact that the market had responded to those earlier
hints more violently than expected. And there was evidently a
decision that they could not risk a further unexpected negativereaction to an actual announcement of tapering. That was probably
a mistake in judgment. By September, a modest reduction in
purchases was widely expected, so I do not think there would have
been a big negative reaction to that announcement. But, by
blinking when they did, I fear that they have made a negative
reaction more likely in the future, because they are now back to
square one, with people once again lacking a clear sense of how
close the Fed is to tapering and thus vulnerable to surprise.
Allison Nathan: Is there actually greater volatility and
uncertainty in the markets as a function of this desire to
communicate more, but not quite getting it right?
Michael Woodford: I don't think so, because the question is: whatwould be people's understanding of policy if the Fed had not tried
to talk about it at all? There would be a lot of uncertainty if the Fed
were adopting a policy of silence, especially given that we are in
unprecedented territory. When conditions are unusual is exactly
the time when trying to provide some explicit guidance is
potentially most valuable, even if it is not a panacea.
Allison Nathan: How important are asset purchases as a signal
of commitment to accommodative policy?
Michael Woodford: I think that a lot of the effects of asset
purchases have been signaling effects.The advantage of
purchases as a signal is that it is something that people see being
done. It's not just talk, so it grabs peoples attention. And the fact
that action is being taken gives some indication of where the
majority of the FOMC stands. But the likelihood that purchases
have had some signaling effect does not necessarily mean that
they are the most effective way of providing the signals that the
central bank wants to send. There has at times been a temptation
to view asset purchases and forward guidance as two alternative
means to providing further stimulus, so that we can avoid having to
say more about future policy if instead we are acting to make
additional asset purchases, and I think that is a mistake. To the
extent that the main goal of purchases is to give a signal, then you
should think consciously about what signal you are trying to give
and be comfortable delivering that signal. Thinking about asset
purchases as part of a coherent and consistent attempt to give
signals about future policy is one thing. But it's very different from
the idea that there will be a mechanical effect of purchases that
allows you to avoid saying anything about future policy intentions.
Allison Nathan: Whats next for Fed communication?
Michael Woodford: It would be valuable for the Fed to provide
more guidance about the process of policy normalization. When
it is clear that they will begin slowing the rate of asset purchases --
which I think will have to be fairly soon, although not necessarily
this year given that they did not do it in September -- the next
obvious question will be how quickly the rest of the unusually easy
policies will be unwound, and what the broader 'exit strategy' will
look like. The last time they spoke about that was in 2011 and its
pretty obvious that what they said then is no longer an operativestrategy. They will need to say something about that at least by the
time that they start tapering, because at that point it will be very
clear that we are no longer in a period of just staying the course.
But a likely reason not to make big statements right now is of
course the imminent hand-off of the Chairmanship in January.
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Goldman Sachs Global Investment Research 6
Top of Mind Issue 18
Kris Dawsey of the GS US economics team
addresses the September 18 taper head-fake,
the future of forward guidance, and Yellen
At the September FOMC meeting, the Fed unexpectedly decided
not to reduce the pace of its asset purchases. This followed
several months of the Fed seeming to communicate that it was
setting up for a taper. The surprise decisionon top of surprisingly
dovish signals on the forward path of the fed funds
rateprompted an 18 basis point drop in the 10-year Treasury yield
from just prior to the announcement to the afternoon close. In this
(relatively new) era of the Fed and other central banks heralding
transparency and going to ever-greater lengths to communicate
their intentions, the key question is: why was the market caught
so off guard?
What not tapering looked like
US 10-year treasury yields, %
Source: Bloomberg.
There are at least a couple of potential explanations. First,
conditions had deteriorated heading into the meeting. Data
surprises were generally negative in August and the first part of
September. Although the market could also observe this
deterioration, it was faced with the challenge of discerning the
degree to which the Fed was focused on the weaker latest month
or two of data, versus the cumulative improvement in the datasince QE3 was introduced, as some communications had
emphasized. As it turns out, the Fed seemed to place more
emphasis on the former than the market expected, with the
meeting minutes explicitly singling out the disappointing July and
August payroll reports as a cause for concern. Worries about the
upcoming fiscal deadlines and potential downside risks to the
economic outlook also seemed to grow, with the situation arguably
just beginning to look more uncertain in the days leading up to the
meeting.
Second, in the context of growing unease about the cyclical
indicators and the fiscal situation, the fear that a decision to taper
might further tighten financial conditions and in particular,
increase mortgage rates apparently gained greater prominence.This concern was amplified by the fact that the Committee was
unable to come to an agreement at the September meeting on
how they might enhance or clarify forward guidance to offset the
potentially more hawkish signal of tapering. The possibility that
further forward guidance might not be as credible in light of the
upcoming transition in Fed leadership was also mentioned. On net,
some things had changed since the Feds earlier
communications, which the Fed seemed to give more weight
to than the market, but the Fed also seemed uncomfortable
following through with the expectations it had largely created
for itself amid the cyclical and market uncertainty.What next for guidance?
We expect the Fed to ultimately enhance its forward guidance
when it chooses to taper asset purchases, at this point most
likely at the March 2014 meeting.It is also possible that they
choose to adjust the guidance before tapering. Possibilities include
a clarification that the current threshold of 6.5% unemployment
that must be met to consider a shift in policy rates only applies if
the committee's near-term inflation forecast is at the target and a
lower threshold would apply if inflation remains below target, an
outright inflation floor, or an outright reduction in the
unemployment threshold. Such changes would be in line with
outcomes suggested by a number of Fed officials, includingBernanke himself at the last post-FOMC press conference. But
what Chairman Bernanke does or does not support is quickly
becoming less important in light of the imminent transition in Fed
leadership at the end of January.
The real question: Yellen
The real question is what will now-Vice Chair Janet Yellen support,
provided she is confirmed as we expect? We think that the
Yellen Fed will be similar to the Bernanke Fed in terms of its
overall policy stance. Janet Yellen has spoken very favorably of
the value of forward guidance in the past, calling economic
outcome-based thresholds for raising rates a major
improvement. As head of a Fed committee on revamping
communications policy, Yellen has shown herself to be a fan of
increased transparency. Perhaps most importantly, she has on
several occasions shown simulations of optimal monetary
policyillustrating the unemployment rate falling below the
current 6.5% threshold before rate hikes begin. For these reasons,
we think she will be supportive of enhancing forward guidance, if it
does not occur before she takes the helm at the March meeting.
It is also likely that Yellen will support reducing the pace of asset
purchases in measured steps, rather than rapidly, if for no other
reason than the likelihood that QE helps to enhance forward
guidanceas demonstrated by volatility in front-end rates
following the start of taper talk in Junealthough she has also
spoken favorably in the past about the efficacy of QE in its ownright.
DID YOU KNOW?
Although the rates market was caught substantially off guardby the FOMCs September 18 decision not to taper, the goldmarket seemed far less surprised by the decision. Gold priceshad risen steadily heading into the meeting consistent withmore dovish expectations that have historically lent support tothe metal, which is traditionally considered a store of value.Gold prices therefore saw a much more muted rally than didrates post the decision, helping to close the large valuation gapthat had opened up between the assets over the prior month(see page 13).
Kris Dawsey, US Economist
Email: Kris.Dawsey@gs.com Goldman, Sachs & Co.
Tel: 212-902-3393
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September 18
FOMC Statement
The taper head-fake and whats next
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Goldman Sachs Global Investment Research 7
Top of Mind Issue 18
Forward guidance explained
Responsible central bankers committing to be irresponsible
The goal of forward guidance is to steer market, as well as public, expectations about the future path of monetary
policy. This guidance can take many forms, including (1) an explicit forecast for future interest rates, which the
Riksbankand some other central banks publish; (2) a simple statement of an intention to keep interest rates low for
some unspecified period, such as an extended period; (3) calendarbased guidance that commits to keeping rates
low until at least a specific point in time; and (4) outcome-based guidance that establishes specific economic
thresholds that must be met before considering a shift in monetary policy, as has been adopted more recently by the
US Federal Reserve (in December 2012 ) and the Bank of England (in August 2013).
Calendar and threshold-based guidance are not necessary to achieve the goals of forward guidance. But these forms
of guidance can have an additional feature that weaker forms of forward guidance do not share: in publicly committing
to keep interest rates at their effective floor until observable parameters are breached, a central bank is voluntarily
tying its own hands and, in doing so, can provide additional stimulus.
The logic of such an approach comes from the fact that spending in the economy today depends partly on
expectations of both future real interest rates and future spending. Therefore, if a central bank can credibly commit to
maintaining low interest rates beyond the point where it would normally choose to raise rates, the expectation of such
irresponsibly dovish behavior in the future can help to stimulate growth today. The problem is that, given theconservative nature of central bankers, it is difficult for them to credibly commit to being irresponsible in this way: once
growth and inflation begin to rise, they will want to renege on their initial commitment and start to raise interest rates.
The public announcement of calendar-based guidance or thresholds can act as a disciplining mechanism to ensure
that they remain irresponsible in the future.
Central bankers and academics describe this as the optimal control approach to monetary policy choosing a
path for interest rates which best meets its objectives over several years as a whole (for the Federal Reserve that
means best fulfilling its dual mandate of full employment and price stability), even if this means committing to a policy
that is suboptimal at future points along that path.
The costs and benefits of adopting an optimal control approach to monetary policy is one that has been discussed
more extensively in the US than in Europe. And, indeed, Fed officials appear to have leaned more in the direction of
this approach than other central banks. In particular, the optimal control perspective has been discussed in a series of
speeches by Janet Yellen, the Vice Chair of the Federal Reserve who was recently nominated to succeed Chairman
Bernanke when he steps down in January 2014.
The accompanying exhibits simulate the differences for the economy under an optimal control path for policy and the
path projected by the FOMC in its September 2013 Summary of Economic Projections. Under the optimal control
approach the funds rate stays on hold for longer (until early 2016), unemployment falls more sharply and inflation is
allowed to overshoot the 2% goal temporarily.
* Based on the September 2013 Summary of Economic Projections.
Source: Goldman Sachs Global Investment Research.
Jari Stehn and Kevin Daly
Unemployment Rate Headline PCE InflationFederal Funds Rate
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Goldman Sachs Global Investment Research 8
Top of Mind Issue 18
Huw Pill, Chief GS European Economist,
discusses the concerns about forward
guidance that seem to be generally greater on
the European side of the pond
The Federal Reserve was an early and enthusiastic adopter of
explicit forward guidance for monetary policy. By contrast, the
leading central banks in Europe initially showed greater reluctance.
Indeed, for some time, the mantra of ECB President Mario Draghi
(and, before that, his predecessor Jean-Claude Trichet) had been
we never pre-commit on the future path of policy interest rates.
More recently, attitudes have evolved. Over the summer, both the
ECB and the BOE officially adopted their own forms of forward
guidance. But, crucially, European policymakers have been at pains
to point out that their guidance should be interpreted as a vehicle
for better explaining their existing policy framework, rather than as
a shift in the strategic framework itself.
In particular, European central banks have avoided giving the
impression that they would be prepared to hold policy rates
lower for longerthan would normally be expected, in an
attempt to ease financial conditions by flattening the yield curve to
a greater than usual extent. Such an approach has been advocated
by some as a way of obtaining additional monetary easing when
(short-term) policy rates reach their zero lower bound.
The objections
The main objection to the pursuit of such a policy is that it
would not be time consistent. In other words, once
macroeconomic conditions began to normalize for example, as
slack is eroded by stronger growth and inflation threatens to rise
the central bank would have an incentive to raise rates regardless
of its previous guidance in order to achieve its stabilization
objectives.
Two consequences could arise from the adoption of such a time
inconsistent approach. On the one hand, it may undermine the
effectiveness of the forward guidance program itself.Because
market participants understand that central banks will want to
renege on its promises in the future, they will not believe the
guidance offered at the outset. This lack of credibility implies that
market expectations will not be influenced by the announcement of
guidance, and therefore the desired flattening of the yield curve
and associated financial easing will not happen.
On the other hand, should the monetary authorities actually deliver
policy interest rates that were lower for longer than normally
required to stabilize the inflation outlook at target, it is natural to
expect that the inflation rate will rise, possibly to undesired
levels.Of course, this may simply represent a short-term
overshoot of the inflation objective. But should longer-term inflation
expectations be destabilized in the course of the overshoot, the
deviation from target is likely to prove more persistent and more
costly to correct.
Central banks in Europe may be particularly concerned about these
issues. For example, given the specific institutional context in the
Euro area, the monetary policy decision making process may find it
more difficult to follow through on guidance offered in the past.Moreover, in many European countries with a recent history of
more elevated inflation, the perceived threat of destabilizing longer-
term inflation expectations could be greater than in the United
States, where the Federal Reserve has built up a strong reputation
over many years.
Related concerns about forward guidance stem from the difficulties
policy makers may face in emphasizing the conditional nature of
that guidance. Markets could interpret forward guidance as a
concrete and irrevocable commitment by the central bank
regarding its policy interest rate path.But central banks need to
retain some discretion to vary policy rates (both immediately andinto the future) as circumstances change unexpectedly (or, in
economic jargon, shocks occur). It is this conditional response to
shocks that imparts monetary policy with its stabilizing properties
for the economy.
Afraid of the consequences in terms of market reaction and/or
volatility that could derive from a central bank failing to deliver on
its (mis)perceived unconditional commitment via forward guidance,
policy makers may cling to the satisfaction of previous guidance,
even when changes in economic considerations dictate otherwise.
This will lead to policy mistakes. Forward guidance can box a
central bank in to an inappropriate policy.
Thresholds not a cure-all
The Federal Reserve has tried to manage this concern by
emphasizing the conditional nature of its forward guidance through
announcing economic thresholds that would trigger a potential re-
evaluation of the guidance and the interest rate decisions that
derive from it. In particular, the Fed has announced thresholds in
terms of the unemployment rate.
But this is not a cure-all. Concerns about this approach stem from
two sources. First, it is unlikely that any single summary
variable be it unemployment or another indicator can
adequately capture the potential impact of all the factors that
should trigger a reassessment of the forward guidance policy.
For example, in practice the Federal Reserve has faced some
challenges arising from fluctuations in the US labor marketparticipation rate, which have reduced the unemployment rate
more rapidly than they may originally have expected.
Second and, in the eyes of many European monetary policy
makers, more importantly introducing thresholds for real
variables such as unemployment can distract the attention of
both policy makers and financial markets from the central
banks underlying mandate to maintain price stability.
Nothing new
Central banks throughout the world recognize that expectations of
future settings of policy interest rates exert a powerful influence
over financial conditions and thus over the economic outlook.
Guiding interest rate expectations is therefore a crucial arguably, thecrucial channel of monetary policy
transmission in most modern views of how the economy works.
As such, all central banks are engaged in forward guidance,
understood as efforts to steer interest rate expectations. Forward
guidance is therefore nothing new: the issues raised by recent
policy experience concern the meansto steer interest rate
expectations, rather than the desirability indeed, necessity of
doing so. And the adoption of more explicit communication to steer
rates, potentially in ways that deviate from normal behavior once
the economy reaches the zero lower bound for nominal rates,
remains justifiably controversial.
Huw Pill, Chief European Economist
Email: Huw.Pill@gs.com Goldman Sachs International
Tel: +44(20)7774-8736
Forward (mis)guidance?
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Goldman Sachs Global Investment Research 10
Top of Mind Issue 18
Robin Brooks of the GS Markets/Economics
teams finds that the jury is still out on whether
words can be as credible as deeds
Federal Reserve Chairman Ben Bernanke argued in July 2013 that a
reduction in asset purchases (tapering) could be offset via forward
guidance, so that the overall level of accommodation, and in turn,
stimulus to the economy, would remain unchanged. But for much
of the rest of the summer, US interest rates moved higher. This
was not the first time markets reacted in the opposite direction of
that intended by central banks attempting to stimulate the
economy through words. As major central banks increasingly
adopt forward guidance approaches to monetary policy, this
unexpected behavior raises the key question: can words really
equal deeds? A look at the recent US and Canadian experiences
suggests (at best) the jury is still out.
The (US) background
The Fed has been experimenting with different forms of forward
guidance for some time, all with the aim of convincing the market
of future Fed behavior in order to boost spending and investment
today. In the December 16, 2008 post-meeting statement, the Fed
said that the funds rate target would be cut to its effective lower
bound and was expected to be kept at this level for some time.
On March 18, 2009 this was strengthened to say that conditions
were likely to warrant a low funds rate for an extended period. In
2011 the Fed started experimenting with calendar guidance,
which committed to low rates over a specified period of time; the
horizon of this period was then extended twice. On December 12,
2012, the Fed shifted to using thresholds, noting that the current
exceptionally low level of interest rates would be appropriate as
long as the unemployment rate remains above 6.5%, inflation
remains below 2.5%, and longer-term inflation expectations remain
well anchored.
Word choice matters, at least sometimes
Have words worked? Intuitively, if forward guidance is credible,
US interest rates (especially in the front end of the interest rate
curve, which the Fed should influence the most) should not be
responsive to data surprises because the Fed has committed to a
certain rate path. Using this measure, calendar guidance
largely worked; front-end interest rates showed almost no
sensitivity to data surprises during the period of calendar
guidance.
But the news is not as good for threshold guidance. The
responsiveness of front-end and especially longer-dated rates
to data surprises rose sharply with the switch to thresholds.
Some of this may have been intentional - low rate volatility under
calendar guidance may have been seen by the Fed as working too
well, making the market too complacent to cyclical conditions and
the possibility of rate hikes, which could give rise to financial
imbalances. But the extent to which it happened and the fact that
the sensitivity to data rose back to pre-crisis levels may ultimately
have played a role in the Feds surprise decision not to taper, which
abruptly sent rates lower across the curve. In the end, deeds
were stronger than words, and forward guidance at least fornow is back to the drawing board.
Thresholds on, data sensitivity up
Sensitivity of changes in 3-year yield 2-years forward to positive US
MAP surprises, bps (higher value = higher sensitivity)
Source: Goldman Sachs Global Investment Research.
The Canadian Experience
The Bank of Canada (BOC) experimented with forward guidance in
the aftermath of the global financial crisis. On April 21, 2009, the
BOC cut its policy rate to what it considers the effective lower
bound (25 bps), using up its conventional monetary policy tools. In
conjunction with that, it provided calendar guidance, committing
to keep rates at their low level until the end of the second quarter
of 2010, conditional on the inflation outlook. This language was
kept until March 2010, with the BOC raising its policy rate to 0.5%
in June of that year.
The yield curve for Canadian rates flattened somewhat on the
announcement, as uncertainty over the direction of future
monetary policy lessened. However, better-than-expected data
in the United States in June of 2009 prompted Canadianinterest rates to rise, as markets started looking to the escape
clause of the BOCs conditional commitment. In this case, it
seems words (no matter what the choice) were not enough.
Forward guidance: Derailed by data
%
Source: Bloomberg.
Deeds over words
But for the US and Canadian experiences the counterfactual is
what matters. While in absolute terms interest rates moved higher
seemingly more driven by data than by words they may still
have been lower than without forward guidance. As such, the jury
is still out on how well forward guidance works. What is clear,though, is that markets prefer deeds to words.
Robin Brooks, Senior Markets Economist
Email: Robin.Brooks@gs.com Goldman, Sachs & Co.
Tel: (212) 902-8763
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calendar guidance
January 25, 2012
calendar guidance
December 12, 2012
threshold guidance
Data sensitivity above the 2-year tenor fell sharply withthe Feds introduction of calendar guidance (Aug. 9, 2011
and Jan. 25, 2012) but then has been rising sharply
above what is normal wi th the shift to thresholds on
Dec. 12, 2012
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Can words really equal deeds?
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Goldman Sachs Global Investment Research 11
Top of Mind Issue 18
Implications of central bank communication
FXThomas Stolper& Team
Unconventional monetary policies need to be considered as extensions of traditional monetary policy. In that
sense, we would expect a dovish surprise to lead to currency depreciation and vice versa. The problem with non-traditional policies is that they are not as easily comparable across countries as traditional
policy rates, generating substantial uncertainty. Market participants have long looked at longer maturity interestrates to compare cross-country differences in non-conventional policies. But these relationships also change.Calendar guidance introduces less volatility into bond yields than threshold guidance, for example.
Often it appears that gauging the distance from the stated policy target gives the best indication of central bankstance. Currencies are likely to weaken when their central banks undershoot their individual target by alarger margin than others.
RatesFrancescoGarzarelli& Team
Although forward guidance has evolved significantly since its introduction by the Fed around 2008, behind italways laid an attempt to keep expectations of short term rates anchored around zero for a sufficient period oftime into the future.
During its first implementation in the form of calendar guidance, rate expectations became increasinglyanchored to their lower bound, to the point that long-term rates were unresponsive to macro developments andterm premium was eroded across the curve given the low volatility.
The implementation of threshold guidance has proven to be more challenging, in particular as it is seen by themarket as intrinsically intertwined with QE. Proof of this was the sharp rates sell-off during the summer drivenby the expectation of an earlier policy rate hike based on the assumption that the FOMC was going to taper inSeptember and the rally once the decision was delayed.
More recently, economic data have been mixed and markets have pushed out expectations for the first hike,with implied volatility moving down to levels last seen around Bernankes testimony before Congress in May.
We believe that markets will not unwind the term premium now built into the yield curve and that 10-yrgovernment yields will smoothly drift higher towards our year-end forecasts of 2.75% for US Treasuriesand 2% for German Bunds. We forecast a further sell-off in 2014, as stronger expected growth pushes theeconomy towards the Feds thresholds, influencing expectations of rate hikes.
CreditCharlieHimmelberg
& Team
We think that forward guidance is a more effective stimulus to credit risk appetite and credit creationthan QE.
But tapering is not tightening if it is accompanied by improvements in forward guidance.
Based on our conversations with investors, we think that the market is giving this point too little weight, payingtoo much attention to rates risk and QE tapering, and not enough attention to the likelihood of more dovishtailwinds from forward guidance.
We are therefore more bullish than the market on headline risks from the Fed over the next few quarters.
More generally, we think credit remains fairly valued. Credit quality remains strong, and the above argumentsplus the prospect of better growth means that the outlook for risk-taking remains favorable.
EquityDavid Kostin(US)
Kathy Matsui(Japan)
Tim Moe
(Asia ex-Japan)
Peter Oppenheimer(Europe)
Helen Zhu(China)& Teams
Quantitative easing (QE) has supported global equity markets in recent years, and everything else equal thepotential tapering of asset purchases is likely to be a headwind across stock markets. However, DM equitiesshould still be able to perform in an environment where policy is tightened as a response to a better DM growthoutlook, at least when measured over slightly longer horizons.
Equity investors are concerned that forward guidance will be an imperfect substitute for QE, thoughultimately the fundamental linkage of these policies to the equity market is through interest rates, which may beanchored by forward guidance. Our US Economists believe forward guidance is a more effective tool for drivinggrowth and keeping rates low.
In the US we have found Fed commentary to be as impactful to equity returns as changes in policy rates. Ouroutlook for continued easy monetary policy via low rates and forward guidance supports pro-cyclical areas of themarket such as growth, weak balance sheets and low return on capital. Communication that implies tighteningcould have the opposite effect over shorter time horizons.
Looking across the global equity landscape, EMs have generally responded more negatively to a potentialtightening of US policy, especially those with significant current account deficits. On the other hand, thenormalization of unconventional policy in the United States is likely contingent upon an economic growthrecovery, which in turn would bode positively for global equity markets.
CommodityJeff Currie& Team
The impact of central bank easing on commodity markets has likely been limited; it is the pace of economicactivity and not forward expectations of such activity that drive physical commodity markets.
The exception is gold, as gold and US real interest typically move with a strong inverse correlation. Thus, Fedeasing has been broadly supportive of gold prices.
But the pass through of future easing on rates and ultimately gold prices is likely shifting; as threshold forward
guidance is inherently data dependent, the correlation between gold and economic activity will likely return to itspre-QE higher level. Under our economic forecast for above trend growth in 2014, we forecast further declines ingold prices next year.
Over the long term, the expansion of the Fed balance sheet through QE could spur inflationary pressures,lending support to gold prices. But the substitution of QE for forward guidance may limit this potential upside.
Snapshot of our views
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Goldman Sachs Global Investment Research 12
Top of Mind Issue 18
Jari Stehn of our US economics team
addresses the shifting preference towards
forward guidance (FG) from asset purchases
(QE), but the difficulty is in the disentangling
The Fed has used both asset purchases (QE) and forward
guidance extensively since reaching the zero bound for the federal
funds rate in late 2008. Initially, the FOMC viewed QE as a highly
effective tool in easing financial conditions and supporting the
economy. In 2011, for example, Chairman Bernanke argued that a
wide range of market indicators supports the view that the Federal
Reserve's securities purchases have been effective at easing
financial conditions. Over the last couple of years, however, it
appears that the committees view on the relative reliability of its
two unconventional tools has shifted. In 2012, for example,
Bernanke stressed in his Jackson Hole speech that both the
benefits and costs of nontraditional monetary policies areuncertain. This September, Bernanke stated that forward
guidance is actually the stronger, more reliable tool.
Bernanke speak
Source: Federal Reserve Board.
From QE to FG
We see two main reasons why the committees thinking might
have evolved toward favoring forward guidance. First, it appears
natural for the efficacy and costs of the two policies to changeover time. Bernanke said explicitly in 2012 that the costs and
benefits of unconventional policies will also vary over time,
depending on factors such as the state of the economy and
financial markets and the extent of prior Federal Reserve asset
purchases. A larger balance sheet, for example, would be
expected to make the effects of additional QE more uncertain.
Likewise, the effectiveness of using additional forward guidance
would be expected to depend on how far market pricing is from
the committees view on the path of the funds rate.
Second, a number of academic studiesincluding work
conducted at the Fedsuggest that the efficacy of QE has
fallen relative to forward guidance.Most notably, Michael
Woodfords presentation at last years Jackson Hole conferenceargued forcefully that forward guidance is a more powerful tool
than asset purchases. In addition, more recent studies of the
magnitude of QEs impact have produced estimates considerably
different from earlier studies, likely increasing Fed officials
uncertainty.
We agree
Our own research is consistent with the view that forward
guidance is a more powerful and reliable tool than asset purchases.
Specifically, our results suggest that a given change in long-
term Treasury yields is about twice as effective in easing
broader financial conditions when it comes through forward
guidance as when it comes through asset purchases.
Moreover, we found that the accuracy of these estimates is
notably higher for the effects of forward guidance than QE.
Forward guidance twice as effective
Days since policy action (horiz. axis);basis points (vert. axis)
Source: Goldman Sachs Global Investment Research.
These considerations were likely one reason for the committees
taper talk this summer. In particular, Chairman Bernanke arguedthat Fed communication was primarily about adjusting the mix of
instruments away from QE towards forward guidance.
Difficult disentangling of QE and FG
The subsequent sharp tightening of financial conditions, however,
suggests that it is difficult to cleanly separate the effects of QE and
forward guidance in practice. In particular, the sharp sell-off
suggests that the pace of QE can act as a signaling device for the
committees intentions for future policy and therefore affect the
credibility of its forward guidance. So, when the committee raised
the possibility of tapering, the market sold off sharply because
investors pulled forward their expectations for the date of the first
funds rate hike.
This interaction between QE and forward guidance supports
our expectation that the FOMC will not want to taper its asset
purchases until the recovery has gained momentum.Although
the uncertainty is considerable, we currently expect the committee
to taper at the March 2014 meeting under our economic forecast
and provided that the next round of fiscal deadlines will prove less
disruptive than the most recent set. If this assumption proves
wrong, and especially if there is another lengthy debt ceiling fight
that lasts until close to the March FOMC meeting, the tapering
decision could be delayed even longer.
Jari Stehn, Senior US Economist
Email: Jari.Stehn@gs.com Goldman, Sachs & Co.
Tel: 212-357-6224
2011 2012 2013
Bernanke, February 3, 2011:
"A wide range of market indicators supports the view that the Federal
Reserve's securities purchases have been effective at easing f inancial
conditions"
Bernanke, August 31, 2012:
"...both the benefits and costs
of nontraditional monetary
policies are uncertain"
Bernanke, September 18, 2013:
"We have asset purchases, and we
have rate policy and guidance about
rates. It's our view that the latter, the
rate policy, is actually the stronger,
more reliable tool."
0
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Response of financial conditionsto 25bp easing in 10yr treasury yield
Forward Guidance
QE
Efficacy of QE versus FG
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Lasse Holboell Nielsen of the GS European
economics team discusses lessons the ECB
can learn from the Scandinavian forward
guidance pioneers
Forward guidance is not a policy reserved for only extreme
situations. Indeed, well ahead of the global financial crisis and
before the zero lower bound of policy rates motivated some
central banks to explore the role of communication tools to achieve
further easing, Norways Norges Bank introduced a form of
forward guidance in 2005, while Swedens Riksbank followed soon
after in 2007.
Explicit but conservative
The Scandinavian central banks form of forward guidance is
among the most explicit in nature: both Norges Bank and the
Riksbank publish a policy rate path several times a year detailingthe level of the policy rate expected by the (majority) of the
Executive Board of the central bank over their forecast horizon
(around three years). In addition, the Scandinavian central banks
publish a range of economic forecasts, such as growth, inflation,
the output gap and the unemployment rate.
Although the form of forward guidance may be one of the most
explicit currently in place, the nature is more conservative: the
policy rate path is a conditional estimate of future policy rates -
based on the economy and market conditions not a commitment.
With no intention of attempting to tie their hands in the way that
Fed-style forward guidance aims to do by promising to keep rates
lower for longer than would normally be the case, Norges Bank
and the Riksbank maintain full discretion at all times. Forwardguidance in Scandinavia is therefore a pure communication tool
rather than an innovation in monetary policy strategy.
Shaping expectationsRiksbank style
%
Source: Riksbank, Goldman Sachs Global Investment Research.
Relevant for the ECB?
Scandinavian central banks lengthy experience with forward
guidance may be more relevant for the ECBs nascent forward
guidance than what one might immediately think.While theECBs style of forward guidance is rather vague, stating only that
policy rates will remain at current or lower levels for an extended
period of time, compared to the Scandinavian central banks
detailed policy rate paths, both the ECB and Norges Bank/the
Riksbank maintain full discretion of their policy rates at all times.
This is a crucial similarity. And with a shared fundamental
underpinning of forward guidance, the Scandinavian experience
may shed light on whether a more explicit form of forward
guidance by the ECB, while maintaining full discretion, might help
the ECB more effectively influence Euro area money market rates.
Gains from transparency despite discretion
A look at how past shifts in the Riksbanks published policy
rate path have impacted market pricing suggests that changes
to the policy rate path can be just as important to shaping
forward market pricing as changes to actual policy rates.
Because the form of communication at the Riksbank is so explicit,
this experience provides a likely upper bound to what can be
achieved (e.g., by the ECB) with a fully transparent form of forward
guidance that still allows for full discretion.
and Norges Bank style
%
Source: Norges Bank, Goldman Sachs Global Investment Research.
While we do not expect the ECB to adopt much more explicit
forward guidance, let alone to actually publish a policy rate path any
time soon, the Riksbank experience suggests that the ECBs
impact on market rates may be enhanced by increasing the
information available to the market regarding the ECBs view
of future likely policy developments.This could take the form of
increasing the length of the ECBs forecast horizon (currently only
between 1 to 2 years) or providing a greater account of the
Governing Councils deliberations.
DID YOU KNOW?As recently as two decades ago, most central banks activelyavoided communicating about monetary policy. According toJanet Yellen, the current Vice Chair of the Federal Reserve whowas recently nominated to succeed Chairman Bernanke:Montagu Norman, governor of the Bank of England in theearly 20th century, reputedly lived by the motto never explain,never excuse. The conventional wisdom among centralbankers was that transparency was of little benefit formonetary policy and, in some cases, could cause problems thatwould make policy less effective.Source: Janet Yellen, Speech: Communication in Monetary Policy,April 4, 2013.
Lasse Holboell Nielsen, Senior European Economist
Email: LasseHolboell.Nielsen@gs.com Goldman Sachs International
Tel: +44(20)7774-5205
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Actual policy rateExpected policy rate paths
Scandinavian monetary policy forward guidance is a
forecast, not a commitment, which has been important
given huge deviations in the past of actual policy rates
versus forecasted paths...but analysis shows that such
policy rate paths still affect market pricing.
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Lessons from forward guidance pioneers
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Fed speaks, market listens
Average Absolute change in 10yr Yield around Fed Events (2001-12),
bp
Words, words, words
GS Fed Speak Tracker* vs. actual policy changes
Source: Bloomberg, Goldman Sachs Global Investment Research. * GS proprietary indicator that aims to capture the predictive content of Fedcommunication for the policy decision at the subsequent meeting.Source: Goldman Sachs Global Investment Research.
Forward guidance: Top of Mind!
Search interest, 100 = highest point of interest
Transparency pioneers (Inflation targeters*)
Date of inflation target* adoption
Source: Google Trends, Goldman Sachs Global Investment Research. Source: Federal Reserve Transparency and Financial Market Forecasts of Short-
Term Interest Rates, Swanson, February 9, 2004; Inflation Targeting: A New
Framework for Monetary Policy? Bernanke, Mishkin, January 1997.
Gold speaking the Feds language
Gold prices, $/oz (lhs); US 10-yr TIPs yield, % (rhs)
Questioning credibility
Japanese breakeven inflation reflected in inflation-indexed JGBs, %
Source: Goldman Sachs Global Investment Research. Source: Bloomberg.
0
1
2
3
4
5
FOMCStatement
Minutes ChairmanSpeech /
Testimony
FRBNYPresident
Speech
Vice ChairSpeech
GovernorSpeech
OtherPresident
Speech 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
-100
-80
-60
-40
-20
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100
Policy Change (left)
Fed Speak Tracker (right)
Tightening
Easing
0
10
20
30
40
50
60
70
80
90
100
Fed issued
"extended
period"
guidance
Fed issued
"mid-2013"
guidance
Fed issued
"2014"
guidance
Fed issued"mid-2015"
guidance
ECB issued
"extended
period"
guidance
Fed issued
outcome-
based
guidance
BOE issued
outcome-
based
guidance
Fed issued
"for some
time"
guidance
Year Country
1990 New Zealand, Chile
1991 Canada
1992 Israel, United Kingdom
1993 Sweden, Finland, Australia
1995 Spain1998 Czech Republic, Korea, Poland
1999 Mexico, Brazil, Colombia
2000 Switzerland, South Africa, Thailand
2001 Hungary, Iceland, Norway
2002 Peru, Philippines
2013 Japan
* In practice, countries that adopted inflation targeting in the 1990s at the
same me s gn can y ncrease e amoun o n orma on a oumoneary po cy reguary reease o e pu c.
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1,300
1,400
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Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13
Gold price US 10 year TIPS yield (right axis, inverted)
September FOMC
-0.5
0.0
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1.0
1.5
2.0
2.5
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13
Noda Cabinetresolution onlegislation for
raising theconsumption tax
Three-partyagreement on
raising theconsumption tax
Abe electedLDP leader
BOJintroduces 2%inflation target
Apr 4thunprecedented
easing
Growthstrategy
Finaldecisionon VAT
hike
Central bank communication in picsA special thanks to our US, Europe and Japan economics teams and our commodities team for most of these pics.
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Snapshot of our key forecasts
RevisionNotes
GS
Cons
GS
Con
s
GS
Cons
GS
Cons
GS
C
ons
GS
Cons
2013
2014
2013
2014
Global
2.8
2.8
3.6
3.5
-
-
-
-
-
-
-
-
-
-
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US
1.6
1.6
2.8
2.6
1.38
1.32
1.40
1.27
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1850
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0.13
0.13
2.75
3.25
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0.9
0.9
1.38
1.32
1.40
1.27
2950
3
010
3200
3250
0.50
0.50
-
-
GERMANY
0.6
0.5
2.0
1.7
1.38
1.32
1.40
1.27
-
-
-
-
-
-
2.00
2.50
CHINA
7.6
7.6
7.7
7.4
6.16
6.12
6.15
6.07
-
-
11000
-
6.00
6.25
-
-
BRAZIL
2.6
2.4
2.3
2.4
2.25
2.32
2.40
2.43
-
-
-
-
10.00
10.25
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Current Activity Indicator (CAI)
Measures the growth signal in the major high-frequency activity indicators for the economy. Gross Domestic Product (GDP) is auseful but imperfect guide to current activity. In most countries, GDP is only available quarterly, is released with a substantialdelay, and initial estimates are often heavily revised. GDP also ignores important measures of real activity, such as employmentand the purchasing managers indexes (PMIs). All of these problems reduce the effectiveness of GDP for investment and policydecisions. Our CAIs are alternative summary measures of economic activity that attempt to overcome some of these drawbacks.We currently calculate CAIs for the following countries: USA, Euro area, UK, Norway, Sweden, China, Japan, Hong Kong, India,Indonesia, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand, Australia and New Zealand.
Financial Conditions Index (FCI)
Financial conditions are important because shifts in monetary policy do not tell the whole story. Our FCIs attempt to measure thedirect and indirect effects of monetary policy on economic activity. We feel they provide a better gauge of the overall financialclimate because they include variables that directly affect spending on domestically produced goods and services. The indexincludes four variables: real 3-month interest rates, real long-term interest rates, real trade-weighted value of the exchange rateand equity market capitalization to GDP.
Global Leading Indicator (GLI)
Our GLIs provide a more timely reading on the state of the global industrial cycle than the existing alternatives, and in a way thatis largely independent of market variables. Global cyclical swings are important to a huge range of asset classes; as a result, wehave come to rely on this consistent leading measure of the global cycle. Over the past few years, our GLI has provided earlysignals on turning points in the global cycle on a number of occasions and has helped confirm or deny the direction in whichmarkets were heading. Our GLI currently includes the following components: Consumer Confidence aggregate, Japan IPinventory/sales ratio, Korea exports, S&P GS Industrial Metals Index, US Initial jobless claims, Belgian and Netherlandsmanufacturing surveys, Global PMI, GS Australian and Canadian dollar trade weighted index aggregate, Global new orders lessinventories, Baltic Dry Index.
Goldman Sachs Analyst Index (GSAI)
Our US GSAI is based on a monthly survey of Goldman Sachs equity analysts to obtain their assessments of business conditionsin the industries they follow. The results provide timely bottom-up information about US economic activity to supplement andcross-check our analysis of top-down data. Based on their responses, we create a diffusion index for economic activitycomparable to the ISMs indexes for activity in the manufacturing and nonmanufacturing sectors.
Macro-data Assessment Platform (MAP)
Our MAP scores facilitate rapid interpretation of new data releases. In essence, MAP combines into one simple measure theimportance of a specific data release (i.e., its historical correlation with GDP) and the degree of surprise relative to the consensusforecast. We put a sign on the degree of surprise, so that an underperformance will be characterized with a negative number andan outperformance with a positive number. We rank each of these two components on a scale from 0 to 5, and the MAP score
will be the product of the two, i.e., from 25 to +25. The idea is that when data are released, the assessment we make willinclude a MAP score of, for example, +20 (5;+4)which would indicate that the data has a very high correlation to GDP (the 5)and that it came out well above consensus expectations (the +4)for a total MAP value of +20. We currently employ MAP forUS, EMEA and Asia data releases.
Glossary of GS proprietary indices
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Disclosure Appendix
Reg ACWe, Allison Nath
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