In September 2013, the MPC said that a minimum necessary condition for a rise in interest rates was that unemployment should fall below 7%. This was not a sufficient condition and the Committee was also at pains to emphasise that the actual path of rates would depend on the outlook for the economy at the time. Yet quite a few observers viewed the condition as a hard trigger and were confused when rates didn’t immediately and automatically rise in response (memorably, one MP subsequently likened the Committee to “an unreliable boyfriend, blowing hot and cold”). Similarly, in a speech in July 2015[5], the then-Governor Mark Carney said the “the decision as to when to [start raising interest rates] will likely come into sharper relief around the turn of the year”. This was no more than suggestive and was immediately qualified with a remark about the importance of economic developments in the interim: “I am conscious of several important considerations which mean the actual path [of interest rates] almost certainly will not be mechanical, linear or pre-determined.
But perhaps a better way to think of it is to recognise that, thanks to this ability to make credible commitments, Blue essentially gets to choose future as well as current policy. This is a pretty valuable addition to the set of monetary tools when the current interest rate can’t be cut (and if the economy responds sensitively to forward rates). Without it, as you can see, the simulated performance of the economy deteriorates significantly as the neutral real interest rate gets closer to the lower bound (i.e. as the red line approaches the origin). Unable to do much about them, the fully discretionary policymaker will spend quite a bit of time in these low-inflation, low-output traps. But because he effectively controls future as well as current policy, and can credibly “promise to be irresponsible” (i.e. to keep rates low even in the event of positive inflationary shocks in the future), the blue policymaker manages to avoid the worst effects of the lower bound for interest rates. Forward guidance in practice What about the real world? Is it blue or red? In practice, looking at what central banks have actually said about future policy, the boundary between the two is less clear in practice than in the theory. Even a fully discretionary policymaker – one who can’t credibly commit to future policy decisions – may react slightly  differently to incoming data around the lower bound.