What is forward guidance and how is it used in the Federal Reserve's monetary policy?
In today's interconnected world, many central banks communicate regularly and frequently with the public about the state of the economy, the economic outlook, and the likely future course of monetary policy. Communication about the likely future course of monetary policy is known as "forward guidance."
When central banks provide forward guidance about the future course of monetary policy, individuals and businesses will 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 postmeeting 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 (for a review of that experience, see Feds Note "The Effects of FOMC Communications Before Policy Tightening in 1994 and 2004").
In the aftermath of the global financial crisis, the FOMC reduced its federal funds rate target nearly to zero, and then used forward guidance to provide information about likely future monetary policy. For example, the postmeeting 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." The FOMC's forward guidance has evolved over time; eventually, the Committee's guidance indicated that the future path of the federal funds rate would depend upon how future economic conditions changed. In addition, the FOMC used forward guidance language about the flow-based asset purchase program that it undertook in September 2012.
In December 2015, when the Committee decided to begin raising the target range for the federal funds rate from nearly zero--the first change in seven years--it indicated in its postmeeting statement that the timing and size of future adjustments in the policy target range would depend on "realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation." Moreover, the FOMC noted that it expected that economic conditions would evolve in a manner that was consistent with only gradual increases in interest rates.
You can read the entire December 2015 FOMC statement here: http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm
To learn more about forward guidance, see the speech former Chairman Ben Bernanke delivered to the National Economists Club in 2013: http://www.federalreserve.gov/newsevents/speech/bernanke20131119a.htm