Forward Guidance

AAA

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.

INVESTOPEDIA EXPLAINS '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. Central Bank

    The entity responsible for overseeing the monetary system for ...
  2. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  3. European Central Bank - ECB

    The central bank responsible for the monetary system of the European ...
  4. Executives' Meeting of East Asia ...

    An organization of 11 central banks from the southeast and Pacific ...
  5. Accommodative Monetary Policy

    When a central bank (such as the Federal Reserve) attempts to ...
  6. Tight Monetary Policy

    A course of action undertaken by the Federal Reserve to constrict ...
Related Articles
  1. Decoding “Normal” Interest Rates
    Economics

    Decoding “Normal” Interest Rates

  2. What are the key factors that cause ...
    Economics

    What are the key factors that cause ...

  3. What's the difference between monetary ...
    Economics

    What's the difference between monetary ...

  4. A Good time to Check Your Bond Portfolio
    Investing Basics

    A Good time to Check Your Bond Portfolio

Hot Definitions
  1. Halloween Strategy

    An investment technique in which an investor sells stocks before May 1 and refrains from reinvesting in the stock market ...
  2. Halloween Massacre

    Canada's decision to tax all income trusts domiciled in Canada. In October 2006, Canada's minister of finance, Jim Flaherty, ...
  3. Zombies

    Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to ...
  4. Witching Hour

    The last hour of stock trading between 3pm (when the bond market closes) and 4pm EST. Witching hour is typically controlled ...
  5. October Effect

    The theory that stocks tend to decline during the month of October. The October effect is considered mainly to be a psychological ...
  6. Repurchase Agreement - Repo

    A form of short-term borrowing for dealers in government securities.
Trading Center