I believe the LSAPs conducted by the Federal Reserve have had substantial beneficial effects on the U.S. economy and that the objections that have been raised against them are not convincing. Forward guidance about the future policy rate has been used as an unconventional tool in statements by the Bank of Canada, the Bank of Japan, and the Federal Reserve during the crisis. However, forward guidance in the form of published policy-rate forecasts have for several years been a conventional policy instrument for the Reserve Bank of New Zealand, Norges Bank, the Riksbank, and the Czech National Bank. I have long been in favour of the publication of a policy-rate forecast on a regular basis, based on both the existing practical experience of publishing such forecasts and the fact that what matters for the economy and private-sector decisions is not what the policy rate is during the one or few months until the next policy meeting but what the longer interest rates are. These longer rates result from market expectations of future policy rates and term premiums. Publishing a policy-rate path would be the most direct way to affect interest-rate expectations, especially since central banks should have better information about their own intentions than anyone else. Based on the observation that emerging-market economies have received large capital inflows lately, with risks of bubbles and other negative effects, some observers suggest that the effects on capital flows to other countries should be taken into account when, for instance, the Federal Reserve sets its monetary policy.
The challenge for the MPC is to assess when inflationary pressures will be building and thus when we need to start withdrawing stimulus, so that once we have eliminated slack in the economy, monetary policy is consistent with stable, sustainable growth and hence stable inflation around the target (subject of course to the other forces acting on the economy at the time). That’s an extremely optimistic expectation of what policy can achieve, so let me put it slightly differently. The realistic challenge for the MPC is to avoid a big mistake either by choking off the recovery too soon, leaving the economy in a quagmire, or by allowing inflationary pressures to build excessively, requiring a sharp tightening in interest rates (and the potential for another recession) to bring inflation back under control. Forward guidance is a policy framework designed, amongst other things, to help avoid big mistakes. We can encourage and probe growth in the economy by committing not to tighten policy until the economy has used up more of its spare capacity. On one view the policy is simple – we must give the economy plenty of time to establish the recovery before we start to raise interest rates or unwind asset purchases. At another level, some critical judgements are  BIS central bankers’ speeches  3  going to be needed because the timing is inevitably uncertain. Given those uncertainties, forward guidance delivers a framework within which the MPC can explore the scope for economic expansion without putting price and financial stability at risk.