I’m referring to statements such as the conditional commitment we made in 2009 – when we pledged to keep the key policy rate unchanged for a year as long as the outlook for inflation didn’t change. Forward guidance can lower longer-term interest rates by signalling to investors that the policy rate will stay at a given level longer than previously anticipated.
It also provides more certainty about the path for short-term interest rates, reducing the risk premium built into longer-term rates. By lowering the entire yield curve, the policy action affects a wider range of borrowers, boosting demand in the economy and leading to higher output and inflation. For forward guidance to be most effective, it has to be credible.