The Fed has a new chair and, it would seem, one with a very different approach to his predecessors. While much of the attention has, understandably, been focused on the traditional question of how hawkish or dovish Kevin Warsh will be on rates, there are deeper issues at play. In (at least) a couple of areas Chairman Warsh seems to represent a break from the approach of Powell, Yellen and Bernanke, his three immediate predecessors.
The Clark Center’s Finance Expert recently looked more closely at two of those issues: the Fed’s approach to communications and the size of the central bank’s balance sheet. Today’s column will focus on the topic of forward guidance, while next week’s will turn to the questions around the balance sheet.
In the 2000s and the 2010s central bank communication – and various forms of forward guidance – became more important to policymaking, not just in the United States but across the advanced economies.
As the Fed’s own explainer notes:
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. Thus, forward guidance about future policy can influence financial and economic conditions today.
The Federal Open Market Committee (FOMC) began using forward guidance in its post meeting statements in the early 2000s. Before increasing its target for the federal funds rate in June 2004, the FOMC used a sequence of changes in its statement language to signal that it was approaching the time at which a tightening of monetary policy was warranted…
Another example came when responding to the Global Financial Crisis. Then the FOMC reduced its federal funds rate target to nearly zero and used forward guidance to provide information about likely future monetary policy. (The federal funds rate is the primary tool to conduct monetary policy and the rate that banks pay for overnight borrowing in the federal funds market.) The post-meeting statement issued in December 2008 noted that the Committee anticipated that weak economic conditions were “likely to warrant exceptionally low levels of the federal funds rate for some time.”
In other words, central banks recognised that their power to shape expectations about future policy rates is tool with real impacts. This was especially true in the 2010s when short term rates were near the effective lower bound and a strong guidance that they would remain low for an extended period helped to bring down longer term rates.
Kevin Warsh has not been a fan of this approach. He stated at his confirmation hearings that “Unlike many of my colleagues past and present, I don’t believe in forward guidance” and then went further to argue that “I don’t believe that I should be previewing for you what a future decision might be.”
This is quite a shift. At his first Fed meeting as Chair, as Brookings recently noted, he followed through this talk with action:
…at his first Federal Open Market Committee (FOMC) meeting as chair in June 2026, the committee stripped the forward-looking language from its policy statement, and Warsh declined to put his own interest-rate projection in the Fed’s “dot plot”—the quarterly chart of Fed officials’ individual projections for interest rates.
Warsh has been clear on his own objections to forward guidance as a tool:
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.
In other words, he worries that forward guidance means that markets are less likely to price in new information coming from economic surprises.
What does the Finance Expert Panel make of that?
They were asked whether “If the Federal Reserve under Kevin Warsh were to provide substantially less forward guidance and communication than it has done in the recent past, it would measurably improve the functioning of financial markets over his four-year appointed term as chair”?
The panel broadly disagreed but with a high level of uncertainty. Weighed by confidence, 12% of respondents agreed, 31% were uncertain, 53% disagreed and 3% strongly disagreed.
As the uncertain Stefan Nagel of Chicago Booth explained “Greater uncertainty about upcoming policy decisions may generate more volatility. On the other hand, some of the communication about future policy in recent years has also led to confusion. Removing this source of confusion may bring benefits”. Douglas Diamond, also of Chicago Booth, was also uncertain, noting that “Forward guidance did not work well in the 2020s and in any case it is most useful at interest rates near zero. It is useful to reevaluate the policy in any case”.
There is definitely a sense that forward guidance was both a more important tool of policy in the 2010s (near the lower bound) and an easier to deploy one then when the economic outlook was less uncertain. In the more turbulent 2020s it has been trickier to get right.
Still, many of those disagreeing argued that whatever communications policy the Fed wants to adopt it will still need to clearly explain its reaction function (or how it will likely react to new news) to financial markets. As Loretta Mester of Wharton argued, “The Fed needs to provide information on its reaction function: needs to convey its view on future policy conditional on how the economy evolves and not regardless of how the economy evolves. Without this the Fed won’t be able to infer the market’s view on econ as Chair Warsh desires”.
Of course, one person’s “explaining their reaction function” can very much be another’s “offering forward guidance”. The real debate amongst FOMC members is likely to be over exactly where that line is drawn.
