DEFINITION of 'Forward Guidance'

Forward guidance is verbal assurance from a country’s central bank to the public about its intended monetary policy. 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. Federal Reserve System - FRS

    The Federal Reserve System, commonly known as the Fed, is the ...
  2. Forward Forward

    A forward forward is an agreement between two parties to engage ...
  3. Bank Rate

    A bank rate is the interest rate at which a nation's central ...
  4. Forward Points

    Forward points are the number of basis points added to or subtracted ...
  5. Federal Reserve System

    The Federal Reserve System is the central bank of the United ...
  6. Federal Reserve Bank Of Minneapolis

    The Federal Reserve Bank of Minneapolis is one 12 reserve banks ...
Related Articles
  1. Investing

    How the Federal Reserve Devises Monetary Policy

    Learn about the tools the Federal Reserve uses to influence interest rates and economic conditions. Find out the types of action a central bank may take.
  2. Insights

    How Central Banks Control the Supply of Money

    A look at the ways central banks pump or drain money from the economy to keep it healthy.
  3. Insights

    Top 4 Central Banks Dominating the World Economy

    Central banks play an integral role in market economies by maintaining the stability and credibility of national currencies used in those economies.
  4. Insights

    How the Fed Profits From Quantitative Easing

    Central Banks including the U.S. Federal Reserve are making rich profits from stimulative measures such as Quantitative Easing (QE).
  5. Personal Finance

    How Interest Rates Can Go Negative

    Central banks from Europe to Japan have implemented a negative interest rate policy (NIRP) in order to stimulate economic growth.
  6. Insights

    Central Banks Not Equipped for Recession: Bank of America

    As inflation rates remain benign central banks are in no position to handle another recession.
  7. Insights

    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. Financial Advisor

    What to Expect at April's FOMC Meeting

    The Fed won't raise rates Wednesday, but it's worth paying close attention to Yellen's comments about the future trajectory of rates.
  9. Insights

    Not Crazy: Unconventional Monetary Policy

    Unconventional monetary policy, such as quantitative easing, can be used to jump-start economic growth and spur demand.
RELATED FAQS
  1. 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 >>
  2. What is the relationship between inflation and interest rates?

    As interest rates are lowered, more people are able to borrow more money, causing the economy to grow and inflation to increase. ... Read Answer >>
  3. How do I convert a spot rate to a forward rate?

    The spot rate shows the cost of executing a financial transaction today, while the forward rate provides the cost of executing ... Read Answer >>
  4. How do central banks acquire currency reserves and how much are they required to ...

    A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign ... Read Answer >>
Trading Center