If, however, the exchange rate is forcefully headed in a certain direction, no central bank can withstand this trend for any length of time. This has been the experience throughout the world, wherever there is free movement of capital between countries. This was also the experience of the Central Bank of Iceland when it attempted to check the slide of the króna from mid-year 2000 to autumn 2001. To demand now that the Central Bank adopt exchange rate objectives is unrealistic. The only option to peg the currency is to return to former practices and introduce currency restrictions, but who wants to go back to that? Cutting interest rates beyond what the Bank’s inflation targets allow, in order to force down the exchange rate, would be highly inadvisable. The nominal exchange rate might temporarily drop somewhat, but it is practically certain that inflation would once more heat up and soon we would end up with the same real exchange rate as before, in addition to having kindled the flames of the next period of overheating and instability. Slowdown in the economy After a protracted period of high economic growth, which ended in overheating, we now have a slight slowdown in the economy and increased unemployment. It has, among other things, been claimed that this slowdown is in particular the result of a tight monetary policy.
There is now a consensus view among central bankers that providing information about policy intentions enhances the effects of monetary policy. However, no consensus has emerged on how to provide it. We may distinguish between three main categories of forward guidance: The traditional form of forward guidance has been to give qualitative statements about future intentions. For instance, some central banks have indicated the anticipated direction of the next change in the policy rate. In 1999, Norges Bank started to make statements such as “the probability that the next change in interest rates will be an increase is greater than the probability of a reduction”. Another example is the Federal Reserve, which has used “code” words such as “bias towards” or “balance of risks”, indicating the same. 3  According to Geraats (2006): “Transparency of Monetary Policy: Theory and Practice,” CESifo Economic Studies 52 (1), central banks seem to have embraced transparency for its perceived economic benefits, rather than accountability requirements. 4  To illustrate, we may consider an inflation-targeting central bank facing inflation below the target. In order to reach the inflation target in this situation, promising to allow inflation to overshoot the target later might help increase inflation today. Commitment in this sense would in practice involve some form of price-level targeting, rather than inflation targeting. 2  BIS central bankers’ speeches  A second approach to forward guidance has been adopted by some central banks when key policy rates have been at a zero lower bound.