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March 12, 2014

Central banks in forward guidance rethink

“Economists at the Bank for International Settlements, the so-called central bankers’ bank, saw more clearly than most before 2008 the imminent global financial crisis. So we should pay close attention now that Andrew Filardo and Boris Hofmann of that institution have lobbed a well-aimed grenade into the arcane monetary debate relating to forward guidance on the level of interest rates.

“They argue in the BIS Quarterly Review that forward guidance can indirectly create financial stability risks if monetary policy is fearful of adverse market reactions. This could lead to undue delay in the normalisation of monetary policy after quantitative easing.

“Put in plain language, there is a risk that investors are taking on excessive risk because they believe central bankers will give them ample advance warning of rising rates. Forward guidance could, in effect, give new life to the old fiction that everyone can sell at the top.

“The Basel-based economists also warn that recalibration of guidance could lead to disruptive market reactions.”

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Read full Financial Times article here.

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