Forward Guidance: Theory versus Reality

Mainstream monetary economics posits that the Federal Reserve influences economic activity by shaping expectations about the future. According to theory, when the Fed provides “forward guidance” about the future course of monetary policy, consumers and producers adjust their spending, hiring, and investment decisions accordingly. Forward guidance, in turn, can be communicated to the public via statements from Fed officials or public understanding of a policy rule that leads the Federal Open Market Committee to adjust its target for the federal funds rate. This theory might, or might not, be an accurate description of how Federal Reserve actions are transmitted to aggregate spending and prices. But, for the time being, it is useful to examine the nature of forward guidance that the Fed is delivering to the public.