Forward guidance, time inconsistency, and monetary policy

Today’s commentary
Over the past few months, the world’s central banks have turned to forward guidance as a central focus of monetary policy. This tool is untested as a central component of monetary policy and has been thrust into the spotlight only because we are at or near the zero lower bound. I believe credibility to prevent time inconsistency and markets’ frontrunning central banks will be a major theme going forward. In Europe, default and redenomination risk present special challenges.
Before the crisis, policy rates were much higher everywhere in developed economies. However, the magnitude of the financial crisis caused central banks to slash interest rates aggressively - so much so, that rates can be cut almost no further. Japan was already at the zero lower bound when crisis hi...


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