Forward Guidance

DEFINITION of 'Forward Guidance'

Verbal assurances from a country’s central bank to the public about its intended monetary policies. Forward guidance attempts to influence the financial decisions of households, businesses and investors by letting them know what to expect from interest rates (to the extent that the central bank can influence those rates). The central bank’s clear messages to the public are one tool for preventing surprises that might disrupt the markets and cause significant fluctuations in asset prices. Forward guidance is a key tool of the Federal Reserve in the United States. Other central banks, such as the Bank of England, the European Central Bank and the Bank of Japan, use it as well.

BREAKING DOWN 'Forward Guidance'

In the United States, the Federal Reserve’s Federal Open Market Committee has used forward guidance as one of its major tools since the Great Recession. Through the use of forward guidance, the FOMC intends to help interest rates remain low to improve credit availability and stimulate the economy.

Forward guidance consists of telling the public not only what the central bank intends to do, but what conditions will cause it to stay the course and what conditions will cause it to change its approach. For example, the FOMC in late 2013 and early 2014 said that it would continue to keep the federal funds rate at the lower bound at least until the unemployment rate fell to 6.5% and inflation increased to 2% annually. It also said that reaching these conditions would not automatically lead to an adjustment in Federal Reserve policy. Janet Yellen, sworn in as Fed Chair in 2014, is a strong proponent of forward guidance.

With some sense of where the economy might be headed, individuals, businesses and investors can have greater confidence in their spending and investing decisions, and financial markets may be more likely to function smoothly. For example, if the FOMC indicates that it expects to raise the federal funds rate in six months, potential homebuyers might want to get mortgages ahead of a potential increase in mortgage rates.

RELATED TERMS
  1. Bank Rate

    The interest rate at which a nation's central bank lends money ...
  2. Monetary Policy

    Monetary policy is the actions of a central bank, currency board ...
  3. Federal Reserve Bank

    The central bank of the United States and the most powerful financial ...
  4. Target Rate

    The interest rate charged by one depository institution on an ...
  5. State Bank

    A financial institution that has been chartered by a state to ...
  6. Federal Funds

    Excess reserves that commercial banks deposit at regional Federal ...
Related Articles
  1. Economics

    What Does a Central Bank Do?

    A central bank oversees a nation’s monetary system.
  2. Personal Finance

    The Banking System: Federal Reserve System

    ByStephen D. Simpson, CFA The central bank of the United States is the Federal Reserve System. The Federal Reserve System came into being in 1913, after the passage of the Federal Reserve Act ...
  3. Personal Finance

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.
  4. Economics

    The Federal Reserve: The FOMC Rate Meeting

    So far we've learned about the structure of the Federal Reserve and its duties, the Federal Open Market Committee (FOMC), the tools of monetary policy and the federal funds rate. Now we're going ...
  5. Economics

    Understanding the Bank Rate

    Bank rate is a term describing the interest rate a country’s central bank charges its domestic banks on loans it makes to them.
  6. Economics

    Earnings Guidance: Can It Accurately Predict The Future?

    Explore the controversies surrounding companies commenting on their forward-looking expectations.
  7. Economics

    Why Deflation Is The Fed's Worst Nightmare

    The measures taken by central banks seem to be winning the battle against deflation, but it is too early to tell if they have won the war.
  8. Economics

    How Federal Open Market Committee Meetings Drive Rates And Stocks

    Janet Yellen's first Federal Open Market Committee (FOMC) meeting - and its aftermath - is an important bellwether for the immediate future of the U.S. economy.
  9. Economics

    How Unconventional Monetary Policy Works

    Unconventional monetary policy, such as quantitative easing, can be used to jump-start economic growth and spur demand.
  10. Forex Education

    How Inflation-Fighting Techniques Affect The Currency Market

    Central banks use these strategies to calm inflation, but they can also provide longer-term clues for forex traders.
RELATED FAQS
  1. How accurate is the forward rate in predicting interest rates?

    Find out why forward rates are inconsistent and limited predictors of actual future interest rates, primarily because the ... Read Answer >>
  2. When was the last time the Federal Reserve hiked interest rates?

    Learn about when the U.S. Federal Reserve last increased the federal funds target rate, which was in June 2006 after the ... Read Answer >>
  3. What are the most important interest rates?

    Learn about the most important interest rates in the economy; the Federal funds rate and discount rate are set by the Federal ... Read Answer >>
  4. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ... Read Answer >>
  5. How does the Federal Reserve's set discount rate affect my personal finances?

    Discover how the Federal Reserve implements its chosen monetary policy through its discount rates, and how these actions ... Read Answer >>
  6. How do central banks impact interest rates in the economy?

    Learn how central banks such as the Federal Reserve influence monetary policy in the economy by increasing or decreasing ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center