Home / Opinion / Views /  The coming schism: What defines ‘forward guidance’?

So here come a riddle, here come a clue

If you were really smart, you’d know what to do

–Uh-Oh, Love Comes To Town by Talking Heads

Central bankers have traditionally trafficked enigmas, scattered conundrums and promoted arcane concepts when communicating with the lay public. The financial crisis of 2008 forced them to simplify and shoot straight. The aftermath of the pandemic and, strangely, the ripple effects of the Russia-Ukraine war may once again force central banks to review how they communicate with households, firms and markets. A reworked communication tool-kit for central banks is clearly in the works.

Reserve Bank of India (RBI) Governor Shaktikanta Das provided some insights into this work in progress. In a recent address, Das said: “…while forward guidance can be a useful policy instrument in an accommodative monetary policy phase, it can be quite difficult to provide coherent and consistent guidance in a tightening cycle. The difficulty gets further compounded in the current environment of high uncertainty. Such forward guidance may even have destabilising effects on financial markets, especially if the subsequent policy actions are at variance with earlier pronouncements. Central bank communication in the current context has thus become even more challenging than the actual policy actions."

At first, it might seem as if Das is ignoring the narrative that emerged from central bank actions post the Great Inflation of the 1970s and 1980s; or even papering over the Indian experience of the past four decades when a succession of central bank governors provided “coherent and consistent guidance in a tightening cycle" and managed to train inflation and inflationary expectations with varying degrees of success. In fact, a string of RBI governors—including Y.V. Reddy and D. Subbarao—frequently indulged in hawkish messaging to markets, punctuated with numerous confrontations with the government (which also acted as signals).

But that will be misreading Das; his focus is on the phrase “forward guidance", which is going out of favour even in central banks of advanced economies. US Federal Reserve chairman Jerome H. Powell, after the central bank’s July meeting, said it was better to go with a meeting-by-meeting approach rather than provide forward guidance, as the Fed had been doing since 2008.

Central banks could afford to provide forward guidance and use it to shape expectations over the past decade because economies were characterized by low inflation and interest rates. There was little that could go wrong, though growth forecasts often missed the mark. But with most macroeconomic variables in flux now—high inflation, broken supply chains, slowing growth, rising debt levels—offering forward guidance could become a fool’s errand. European Central Bank (ECB) executive board member Philip R. Lane has said that an uncertain economic environment and rising rates make a meeting-by-meeting approach better suited to calibrating monetary policy than forward guidance.

Central bank governors are providing a different kind of guidance these days, one that unequivocally conveys a path of rate action for the near future. Jerome Powell was categorical at Jackson Hole that there would be no quarter given in the battle against inflation: “…the current high inflation in the United States is the product of strong demand and constrained supply, and ... the Fed’s tools work principally on aggregate demand. There is clearly a job to do in moderating demand to better align with supply. We are committed to doing that job… We will keep at it until we are confident the job is done."

The ECB’s latest monetary policy statement also doesn’t mince words: “We raised the three key ECB interest rates by 75 basis points today, and expect to raise interest rates further, because inflation remains far too high and is likely to stay above our target for an extended period… Our future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach. We stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term inflation target."

So far, so logical. But this is where the RBI governor seems to be treading a grey zone. Das is basically taking issue with Powell’s Jackson Hole statement which sent markets, including those in emerging economies, into a temporary tailspin. It is true that the Fed’s normalization processes—both in 2013 and now—have routinely roiled markets, with debilitating effects in emerging economies. But it also raises questions: does Das’s definition of forward guidance differ from Powell’s? This then points to the possibility of a growing schism in how central banks of rich nations and emerging economies define what constitutes forward guidance.

But, beyond that, Das unwittingly turns the arc-lights on RBI’s guidance record by drawing attention to the Jackson Hole “guidance". RBI has frequently missed the mark with its GDP growth forecasts, which presumably then feed its inflation forecasts and shape its rate policy.

To wit, India’s wholesale price index has been in double digits for almost 18 months now and the consumer price index has overshot the mandated target for almost three quarters. Now is the time to be tough, or even appear to be tough on inflation, and not come across as irresolute.

Rajrishi Singhal is a policy consultant and journalist. His Twitter handle is @rajrishisinghal. 

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