I fear readers will complain that I am beating a dead horse, but I continue to see confusion over monetary policy. In the FT, Andy Haldane has a piece discussing the effectiveness of forward guidance:

Central banks have so far used forward guidance, with a bias to future tightening, to achieve this disciplining effect. And for a fleeting period over the summer, this seemed to be working, with interest rate expectations suggesting rises were more likely than not in the US, UK and eurozone during 2024 and with no rate cuts expected until 2025 at the earliest.

But, like my own attempts with my children, the disciplining effects of these so-called “open mouth” operations has been shortlived. Although central banks’ tighter for longer rhetoric remains largely unchanged, financial markets now expect significant rate cuts in the US, euro-area and UK during the first half of 2024. 

I have exactly the opposite view.  It is true that if forward guidance were effective, then markets would expect policymakers to maintain a restrictive stance until inflation is under control.  But a restrictive stance does not mean high interest rates, it means interest rates above the natural rate.

If current forward guidance is effective, then inflation expectations should moderate.  This will cause a fall in the future expected natural rate of interest (in nominal terms), and a reduction in the future expected policy rate.

I was more pessimistic about inflation a month ago, when I saw 10-year bond yields rise above 5%.  Now that they are back down to 4.2%, I’m becoming a bit more optimistic about the prospects for controlling inflation—and by implication, future rate cuts.

PS.  Otherwise, it’s a good article.  Haldane does a nice job of discussing the intuition behind the time inconsistency problem.  I just think he’s misinterpreted what the recent fall in rates tells us about forward guidance.