Heterogeneous beliefs may weaken effect of forward guidance, paper argues

Fixed-date and state-contingent guidance by the Federal Reserve led some market expectations to converge, but heterogeneous beliefs about inflation and consumption persisted
banquedefrance
The Banque de France

Market expectations of interest rates converged when the Federal Reserve introduced "fixed-date" forward guidance, a working paper published this week by the Banque de France argues. Heterogeneous beliefs among private agents, however, can still weaken the effect of forward guidance, the paper says.

In Forward guidance and heterogeneous beliefs, Phillippe Andrade, Gaetano Gaballo, Eric Mengus and Benoit Mojon present a new set of stylised facts which they say capture disagreement among US market forecasters.

They look at quarterly predictions of the short-term nominal interest rate, the inflation rate and the consumption growth rate from the US survey of professional forecasters (SPF), from 1982 to 2014. The authors measure disagreement by looking at the difference between the 25th and 75th percentiles of individual quarterly forecasts.

The Federal Open Markets Committee's decisions to announce "date-based" and "state-contingent" forward guidance, in August 2011 and December 2012, led to major falls in disagreement on future nominal interest rates, the paper says. Disagreement about future inflation and consumption, by contrast, were largely unchanged.

This "puzzling" difference can be theoretically explained by agents holding heterogeneous beliefs about the central bank's implied policy stance. "Agents can agree on the path of future short-term interest rates for different reasons," the paper says.

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