The Effects of Forward Guidance: What Do We Learn from Staff Forecasts and Survey-Based Expectations?

The path of the policy interest rate expected by financial markets was shifted by the ECB's forward guidance of July 2013. This provides tentative evidence that market expectations had, in advance of the forward guidance, diverged from a path that would have been consistent with the ECB's normal policy reaction function. However, the apparent correction could also have been the result of an unusual revision in market expectations of inflation and growth. The potential for negative side-effects from forward guidance through revised expectations of growth, motivates our assessment of the strength of such effects. We use ECB Staff Projections and the Survey of Professional Forecasters' expectations of inflation and growth to show that forecasts were indeed out-of-line with projections of a fitted policy reaction function estimated before the period of imminent forward guidance. We find that, after forward guidance, market expectations became better aligned with projections based on the same fitted reaction function. Growth and inflation expectations were not as significantly revised as was feared. This substantially confirms the assertion by Praet (2013) that there was a need for reassertion of the policy rule and that this was effective.