Terence Corcoran: Central bankers drop ‘Odyssean’ forward guidance

Skip to Content News Archives Economy Energy Oil & Gas Renewables Electric Vehicles Mining Commodities Agriculture Real Estate Mortgages Mortgage Rates Finance Banking Insurance Fintech Cryptocurrency Work Wealth Smart Money Wealth Management Investor Personal Finance Family Finance Retirement Taxes High Net Worth FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials More Innovation Information Technology FP500 Podcasts Small Business Lives Told Tails Told Shopping Financial Post Store Obituaries Place a Notice Advertising Advertising With Us Advertising Solutions Postmedia Ad Manager Sponsorship Requests Classifieds Place a Classifieds ad Working Profile Settings My Subscriptions Saved Articles My Offers Newsletters Customer Service FAQ News Economy Energy Mining Real Estate Finance Work Wealth Investor FP Comment Executive Women Puzzmo Newsletters Financial Times Business Essentials This advertisement has not loaded yet, but your article continues below.HomeFP CommentTerence Corcoran: Central bankers drop ‘Odyssean’ forward guidanceWhat will markets do without Odysseus to guide them?Last updated 33 minutes ago You can save this article by registering for free here. Or sign-in if you have an account.Matt Damon as Odysseus in The Odyssey. Photo by Universal StudiosFor a couple of decades the Bank of Canada, the United States Federal Reserve and other central banks have been using “forward guidance” in their public communications to help financial markets figure out where interest rates are going. But not any more, according to the latest statements by central bankers such as Kevin Warsh, the new Trump-appointed Fed Chairman.THIS CONTENT IS RESERVED FOR SUBSCRIBERS ONLYSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.SUBSCRIBE TO UNLOCK MORE ARTICLESSubscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.REGISTER / SIGN IN TO UNLOCK MORE ARTICLESCreate an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.THIS ARTICLE IS FREE TO READ REGISTER TO UNLOCK.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountWhat does this shift in policy mean? Unfortunately, economic papers on monetary policy tend to run to 50-or-more dense pages of economic jargon, graphs and equations that make forward guidance merits and problems near impossible to analyze or explain.Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againOne bit of jargon may help, however. In an 80-page paper in 2012, Chicago Federal Reserve members described one form of forward guidance as Odyssean. That occurs when the U.S. Fed issues a clear statement on future policy that publicly commits a central bank — to, for example, hold interest rates low for the next 12 months — “just as Odysseus committed himself to staying on his ship by having himself bound to the mast.”As filmgoers who contributed to the US$1-billion box office blockbuster will know, Matt Damon in The Odyssey does not mention monetary policy as he screams in agony strapped to the mast.Another forward guidance technique used by central bankers is described as “Delphic,” after the Oracles at the Temple of Apollo at Delphi — although the Chicago Fed economists carefully noted that “The classical Delphic oracle famously made ambiguous utterances. We do not mean ‘Delphic’ in this sense. We use the term simply to describe Federal Open Market Committee statements about the future.”Whether Delphic or Odyssean, central bankers are beginning to pull back on the practice of issuing foreword guidance statements about the future course of monetary policy — although the Bank of Canada’s official perspective is not yet clear. The bank has not formally rejected forward guidance as a routine practice, but it has in recent months refrained from making bold statements about the future of interest rates. In a podcast, Andrew Kelvin, head of Canadian and Global Rates Strategy at TD Securities, said it appears the central bank is being cautious at a time when uncertainty is high. That does not mean the bank is ready to abandon forward guidance — not a surprise given that the global hero of forward guidance is former central bank governor and Prime Minister Mark Carney.All of which means that Bank of Canada Governor Tiff Macklem is unlikely to formally strap himself to any monetary policy masthead or don any Delphic shawl, at least in the near future. Reports last month indicated that Macklem was among central bankers — including European President Christine Lagarde and Bank of England Governor Andrew Bailey — who endorsed anti-guidance perspectives at a meeting in Europe. They called for a creative rethink of the practice, with Macklem paraphrased as endorsing a shift “towards the view that giving markets a highly prescriptive runway is no longer viable.” The International Monetary Fund is also set to launch a review of guidance policies.This advertisement has not loaded yet.This advertisement has not loaded yet, but your article continues below.The Canadian question, therefore, is whether Canada will end up following the explicit anti-Odyssean statements being issued by Chairman Warsh.In Warsh’s view, “financial markets perform best when they react to incoming data. I think the financial markets work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information? The more that markets are paying attention to what’s happening in the real economy, deciding what’s good data and what’s less-good data, the more financial markets can price what they believe is the most likely and what are the tail risks.” Financial markets should be using data, not the words of central bankers.So what is this thing called forward guidance, a policy approach that has been used over the past two decades? In the Fed’s words, “Forward guidance is a tool that central banks use to tell the public about the likely future course of monetary policy. When central banks provide forward guidance, individuals and businesses can use this information in making decisions about spending and investments.”Is this a legitimate argument?In recent weeks, Warsh has been criticized for his belief that central banks should not be issuing hard monetary policy and interest rate forecasts. By not providing guidance to the financial markets, it is said, Warsh “strips away long-term market clarity.”That conclusion, however, is highly debatable, as noted in a recent Wall Street Journal editorial: “Memo to Wall Street: Quit whining about the Federal Reserve. Your clients are paying you (a lot) to make judgments about risks and returns in real time, and it’s embarrassing when you complain now that Daddy Fed isn’t telling you how to do it.” The Journal makes a valid point, especially since central bankers are more than willing to confess that they don’t know what the future holds any more than Wall Street and Bay Street investment and economic institutions.With central bank guidance in front of them, bond traders and others who follow the central bank guidance rather than independent and possibly contradictory guidance are set up to blame central banks when the economy fails to meet the guidance. As the Journal’s editorial put it, there’s the awkward question of “whether Wall Street knows how to do the risk-pricing Mr. Warsh now asks of it. Not since 2008 have trading desks had to make decisions on bond deals without reference to a cheat-sheet” from the Federal Reserve.An IMF official concluded that “as time passes and our understanding deepens, it is logical to reassess the scope and implementation of forward guidance.”A final observation regarding the Fed’s Kevin Warsh. Back in 2014, he wrote a 60-page report for the Bank of England on the subject of central bank “transparency,” which can be seen as comparable to forward guidance. Warsh approved of the idea, providing it met certain conditions and objectives. “Transparency is a powerful tool to help the MPC (Monetary Policy Committee) achieve its objectives. But a transparency regime, if ill-considered or ineffectively pursued, could prove detrimental to the conduct of monetary policy and the interests of the U.K. economy.”Warsh was commissioned to write the paper by the Bank of England’s then governor, Mark Carney, who said he was “delighted” that Warsh had accepted the invitation. “His broad knowledge of central banking and his experience as a member of the Federal Reserve Board will be of particular value in addressing the question.”Oddly, the words forward guidance do not appear in Warsh’s paper, but it is clear that Carney was importing forward guidance to England. Only a year earlier, Carney had delivered a speech in Canada hailing the use of guidance as a vital central bank tool to shape monetary policy.Maybe the IMF could set up a Carney-Warsh debate over whether central bankers should still be ready to become Odysseus.NOTA BENE: Markets should follow data, not central bank guidanceComments by Kevin Warsh, Chairman of the U.S. Federal Reserve, at a news conference on July 16. (Source: Wall Street Journal):“I think financial markets perform best when they react to incoming data. I think the financial markets work less efficiently when they ask a question: How will the Federal Reserve react to that incoming information? The more that markets are paying attention to what’s happening in the real economy, deciding what’s good data and what’s less-good data, the more financial markets can price what they believe is the most likely and what are the tail risks.“Financial market prices are probably the most important source of information to guide central bankers. But when all the financial markets are doing is reflecting back what we’ve said, then we’re taking the most important source of information and we’re being blind to it. I’d like us to create a system where those blinders come off, where markets are following data that they efficiently think is reliable, and they’ll be watching data, we’ll be watching data, they’ll come with better information through market prices to us. We can make more-informed decisions with, ultimately, the goal that I set at the outset: Deliver on the price stability objective that Congress told us to do and that we’ve got to get in the business of doing.”Notice for the Postmedia NetworkThis website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.