Does Forward Guidance Matter in Small Open Economies? Examples from Europe

Jakub Rybacki

doi:10.33119/ERFIN.2019.4.1.1

Jakub Rybacki Collegium of Economic Analysis, SGH Warsaw School of Economics, Poland

DOI: https://doi.org/10.33119/ERFIN.2019.4.1.1

Keywords: Forward Guidance, Interest Rate Projections, Nelson-Siegel Model, Diebold-Mariano Test

Abstract

The effect of forward guidance on interest rate expectations in small, open economies is often described as heterogeneous. There are examples when financial markets adjusted term structure to reflect interest rate forecasts provided in the projections published by the central banks. On the other hand, medium-term expectations can persistently deviate from trajectories presented by decision-makers, influenced by foreign monetary policy. Our aim is to find the maximal forecast horizon where the domestic forward guidance of local banks in European economies affects market interest rate expectations strongly as compared to the ECB policy. We analyzed the term structure of interest rates in Sweden, Norway, and the Czech Republic. Central banks in these three economies provide the most mature forward guidance, e.g., regularly publishing interest rate forecasts with detailed discussions. The three-month interbank rate path calculated with the Nelson-Siegel model was contrasted with both the trajectory of policy rates presented in central bank projections and that implied by the three-month EURIBOR. We found that interest rate expectations were more influenced by ECB policy than by domestic assumptions when the forecast horizon exceeds four quarters.

References

Ball, L. M. (1999). Monetary policy rules, chapter Policy rules for open economies., pages 127–156. National Bureau of Economic Research, Inc.

Brubakk, L., ter Ellen, S., and Xu, H. (2017). Forward guidance through interest rate projections: does it work? Working Paper 2017/6, Norges Bank.

Campbell, J., Evans, C., Fisher, J., and Justiniano, A. (2012). Macroeconomic effects of Federal Reserve forward guidance. Working Paper Series WP-2012-03, Federal Reserve Bank of Chicago.

Detmers, G.-A. and Nautz, D. (2012). The Information Content of Central Bank Interest Rate Projections: Evidence from New Zealand. The Economic Record, 88(282):323–329.

Diebold, F. and Li, C. (2006). Forecasting the term structure of government bond yields. Journal of Econometrics, 130(2):337–364.

Diebold, F. and Mariano, R. (1995). Comparing Predictive Accuracy. Journal of Business and Economic Statistics, 13(3):253–63.

Eggertsson, G. and Woodford, M. (2003). Optimal Monetary Policy in a Liquidity Trap. NBER Working Papers 9968, National Bureau of Economic Research, Inc.

Gajewski, K., Jara, A., Kang, Y., Mok, J., Moreno, D., and Serwa, D. (2018). International spillovers of monetary policy: lessons from Chile, Korea, and Poland. NBP Working Papers 290, Narodowy Bank Polski, Economic Research Department.

Giannoni, M., Patterson, C., and Del Negro, M. (2015). The Forward Guidance Puzzle. 2015 Meeting Papers 1529, Society for Economic Dynamics.

Gurkaynak, R., Sack, B., and Swanson, E. (2005). Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements. International Journal of Central Banking, 1(1).

Harvey, D., Leybourne, S., and Newbold, P. (1997). Testing the equality of prediction mean squared errors. International Journal of Forecasting, 13(2):281–291.

Jain, M. and Sutherland, C. S. (2018). How Do Central Bank Projections and Forward Guidance Influence Private-Sector Forecasts? Staff working papers, Bank of Canada.

Klein, M. C. (2017). Just how much money did the ECB lose on its Steinhoff investment? Financial Times, December 6.

Kool, C. and Thornton, D. (2015). How Effective Is Central Bank Forward Guidance? Review, 97(4):303–22.

Norges Bank (2008). Monetary Policy Report 3/2008. Norges Bank (2009). Monetary Policy Report 1/2009.

Raskin, M. (2013). The effects of the Federal Reserve’s date-based forward guidance. Finance and Economics Discussion Series 2013-37, Board of Governors of the Federal Reserve System (US).

Rubaszek, M. (2016). Forecasting the Yield Curve With Macroeconomic Variables. Econo- metric Research in Finance, 1(1):1–21.

Rudebusch, G. and Williams, J. (2008). Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections. In Asset Prices and Monetary Policy, pages 247–289. National Bureau of Economic Research, Inc.

Svensson, L. (2015). Day One Keynote Address: Forward Guidance. International Journal of Central Banking, 11(4):19–64.

Swanson, E. (2017). Measuring the Effects of Federal Reserve Forward Guidance and Asset Purchases on Financial Markets. NBER Working Papers 23311, National Bureau of Economic Research, Inc.

Taylor, J. (2013). International monetary policy coordination: past, present and future. BIS Working Papers 437, Bank for International Settlements.

Winkelmann, L. (2016). Forward guidance and the predictability of monetary policy: a wavelet-based jump detection approach. Journal of the Royal Statistical Society Series C, 65(2):299–314.