The Emergence of Forward Guidance As a Monetary Policy Tool

Finance and Economics Discussion Series

Divisions of Research & Statistics and Monetary Aﬀairs

Federal Reserve Board, Washington, D.C.

Edward Nelson

2021-033

Please cite this paper as:

Nelson, Edward (2021). “The Emergence of Forward Guidance As a Monetary Policy Tool,”

Finance and Economics Discussion Series 2021-033. Washington: Board of Governors of the

Federal Reserve System, https://doi.org/10.17016/FEDS.2021.033.

NOTE: Staﬀ working papers in the Finance and Economics Discussion Series (FEDS) are preliminary

materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth

are those of the authors and do not indicate concurrence by other members of the research staﬀ or the

Board of Governors. References in publications to the Finance and Economics Discussion Series (other than

acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.

The Emergence of Forward Guidance As a Monetary Policy Tool

Edward Nelson*

Federal Reserve Board

May 7, 2021

Abstract

Forward guidance—the issuance by a central bank of public statements concerning the likely

future settings of its policy instruments—is widely regarded as a new tool of monetary policy.

The analysis in this paper shows that Federal Reserve policymakers from the 1950s onward

actually accepted the premises of forward guidance: the notion that longer-term interest rates are

key yields in aggregate spending decisions; and the proposition that indications of intentions

regarding future short-term interest rate policy can affect longer-term rates. Over the same

period, they were nevertheless wary about providing forward guidance regarding short-term

interest rates, fearing that this could generate untoward market reactions or lock the Federal

Open Market Committee into inappropriate rate settings. They concentrated on describing future

policy in terms of achievement of economic objectives, with their commentary on interest-rate

prospects usually confined to consideration of the longer-term factors affecting rates. Even in

these years, however, there were infrequent occasions—notably in 1974 and 1982—when

policymakers provided more explicit guidance regarding the path of short-term rates. In the

1990s, a consensus developed in U.S. policy circles that was more receptive toward the notion of

guiding longer-term interest rates by providing indications of future FOMC actions. This

consensus developed even before concerns about the lower bound on short-term rates became

prevalent in U.S. policymaking. The new mindset, which stressed the stabilizing effects on the

economy of communication of policy intentions, set the stage for the emergence of forward

guidance as a monetary policy tool.

Key Words: Forward guidance, monetary policy tools, monetary policy strategy, interest-rate

forecasts, interest-rate lower bound, Federal Open Market Committee, Federal Reserve.

JEL classification numbers: E43; E58.

* Email: [email protected]. The author is grateful to Ben Bernanke, David López-Salido,

Jón Steinsson, and Lars Svensson for comments on an earlier draft. The author has sole

responsibility for any errors. The views expressed here are the author’s alone and should not be

interpreted as those of the Federal Reserve or the Board of Governors.

1. Introduction

“[I]t is true there are no adjectives, no judgments and no explanations of present actions or

inaction in these [Federal Reserve] statements and reports; nor are there tips, predictions,

threats or promises of future action. Nor, given our present state of knowledge, does it seem

desirable or appropriate that there should be.”—George W. Mitchell, Federal Reserve Board

governor, October 1966

“[I]nfluencing the public’s expectations about future policy actions became a critical tool…”—

Ben S. Bernanke, Federal Reserve chair, October 2011

Forward guidance—the issuance by a central bank of public statements concerning the likely

future settings of its policy instruments—is now a key aspect of monetary policy in the United

States. The study of the properties and implications of forward guidance has also developed into

a vibrant part of the research literature on monetary policy and its effects. Even before forward

guidance became an entrenched component of U.S. monetary policy announcements, Eggertsson

and Woodford (2003) had provided a formal analysis showing that public undertakings to adhere

to an expansionary stance for a stretch of time might serve as a means by which the monetary

authorities could stimulate aggregate demand when their short-term nominal interest-rate

instrument was currently at its zero or effective lower bound (ELB).

In the realm of monetary

policy practice, limited moves toward the inclusion of forward guidance in the Federal Open

Market Committee’s (FOMC) postmeeting policy statements occurred in 2003and2004. The

regular incorporation of forward guidance into FOMC postmeeting statements began in 2008,

when the federal funds rate moved to its ELB. The FOMC’s deployment of forward guidance

regarding the federal funds rate has continued—with many variations being made in the specific

form of guidance provided—in the years since 2008, both in and outside ELB conditions.

The practical experience established through the employment of forward guidance by monetary

policy committees in the United States and other countries has, in turn, had a major influence on

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Mitchell (1966a, p. 3; p. 398 of 1971 printed version). See also Mitchell (1966b, p. 8).

Bernanke (2011, p. 4).

Prior to this, Tobin (1981, pp. 206207) and Krugman (1998, esp. pp. 162, 179180), among others, had pointed

toward a policymaker commitment to generating, or validating, inflation in future periods as a method by which a

central bank could stimulate aggregate demand in ELB conditions. In contrast, however, to Eggertsson and

Woodford (as well as Woodford, 1999), and also unlike much of the twenty-first-century literature on forward

guidance, Tobin and Krugman did not consider in detail what such an articulation of desired outcomes might imply

for the formulation of the central bank’s reaction function.

See, for example, Clarida (2020).

the analytical work that has been done on this policy measure. The research in question has

included efforts to develop classification schemes regarding different types of forward guidance

(for example, Campbell, Evans, Fisher, and Justiniano, 2012); to ascertain the empirical effect of

forward guidance on U.S. longer-term interest rates (for example, Swanson and Williams, 2014);

to bring out cases, in quantitative forward-looking models, in which forward guidance might

either generate outsized effects on economic activity (for example, Del Negro, Giannoni, and

Patterson, 2015, and McKay, Nakamura, and Steinsson, 2016) or have notable limitations in its

ability to stimulate aggregate demand (for example, Levin, López-Salido, Nelson, and Yun,

2010; Campbell, Ferroni, Fisher, and Melosi, 2019; García-Schmidt and Woodford, 2019; Cole,

2020); and to analyze how forward guidance fits alongside other policy tools—including, most

notably, central-bank purchases of longer-term government securities—into the formulation of a

cohesive monetary policy strategy, especially in a situation in which the policy rate is at the ELB

(for example, Engen, Laubach, and Reifschneider, 2015; Svensson, 2015; Bernanke, 2020;

Eberly, Stock, and Wright, 2020).

A perspective on forward guidance that is largely common to these research contributions is

encapsulated in Bernanke’s (2020) grouping of forward guidance among the “new tools of

monetary policy.”

The analysis in the present paper departs from the existing literature in focusing on U.S.

monetary policy in the pre-2003 period from the perspective of forward guidance. In doing so,

this paper fleshes out the grounds on which forward guidance should be considered a new tool.

At the same time, however, the analysis in this paper offers evidence that, in key respects, this

perception warrants considerable reevaluation. The essential concept of forward guidance is, as

documented below, of long standing and was familiar to the policymakers of past eras. This fact

is brought out in this paper via an analytical account covering the relevant developments in U.S.

monetary policy discourse over the five decades to 2003. The examination concerns Federal

Reserve policymaker statements, actions, and discussions that anticipated and prefigured—as

well as those that criticized and rejected—the option of employing the monetary policy tool that

would become known as forward guidance.

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Because the paper is concerned with public communications, the documentary material examined in this paper

consists primarily of Federal Reserve officials’ on-the-record statements (such as those given in speeches and

congressional testimony) rather than material (like FOMC meeting transcripts) that was disclosed only after a multi-

year lag. Some internal material is considered, in order to provide a check on the reliability (as an authentic account

of the views held by those in policy circles) of what was relayed in the public statements.

In particular, this paper traces the emergence of forward guidance as a policy tool in the United

States by highlighting the evolving perspectives, expressed by successive Federal Reserve

policymakers, toward presenting formal or informal public projections of interest rates

(especially of short-term market interest rates closely related to Federal Reserve policy actions).

What emerges from the analysis can be stated briefly. Over these decades, the FOMC evolved

from adhering to what one prominent policymaker called a “you see it as we do it” approach, in

which the Federal Reserve tended not to make statements about the FOMC’s policy stance other

than those pertaining to its immediate policy decision, toward a very different posture—one of

being congenial to the deliberate exercise of a policymaker influence on longer-term interest

rates, through the provision of explicit information about the likely course of the short-term

policy rate. Therefore, the status of forward guidance as a new tool stems from the fact that pre-

2003 policymakers contemplated, but largely rejected, its use as a tool. Even before 2003,

however, there were occasional deviations from this posture. Notably, in 1974, Federal Reserve

chair Arthur Burns felt it necessary to make clear that high nominal interest rates would need to

continue “for a time” as an anti-inflation measure; and a later chair, Paul Volcker, having

presided over a period of very restrictive monetary policy, chose in March 1982 to make an

explicit indication that nominal interest rates would and should fall in the period ahead.

In more detailed terms, the examination in this paper indicates that two key analytical premises

underlying forward guidance—the notion that expectations of short-term interest rates matter for

longer-term rates; and the conviction that longer-term rates figure importantly into private-sector

spending decisions—were well understood and accepted in U.S. policy circles by the mid-

1950s.

However, for many years the granting of these premises did not translate into a

policymaker acceptance of the desirability of forward guidance. This was despite the fact that

there were multiple occasions on which the provision of such guidance was explicitly aired by

Federal Reserve officials when they contemplated their policy options, including in discussions

given in public. Multiple factors underlay policymakers’ aversion, prior to the 1990s, to forward

guidance. These included a view that policymakers’ intentional influence on financial market

prices should be confined to formal FOMC decisions about the immediate policy action and

should not include indications by the Committee (or the Federal Reserve chair) of the future

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For the first of these premises to have a considerable bearing on thinking about monetary policy, it is also required

that expectations of future interest rates are endogenous and are responsive to current central bank policy. This

condition has, very typically, been satisfied, over successive decades, in the economic framework underlying both

practical policy discussions and in formal economic models. Important but infrequent exceptions, noted below,

occurred when prominent economists (like John Maynard Keynes in 1936) or policymakers (like Federal Reserve

Chairman Arthur Burns in 1975) denied a policy-relevant connection between short- and long-term rates.

course of the policy rate. Concern was repeatedly voiced that indications of this kind would

prove unintentionally destabilizing for economic activity. Policymakers also feared that an

articulation of the likely path of short-term rates might limit their prerogatives in future periods.

Against the backdrop of these concerns, policymakers in the 1960s through the 1980s

concentrated on the Fisher relationship—which links expected inflation and the nominal interest

rate—as a means of outlining the likely values to which nominal interest rates would converge

under maintenance of the current policy strategy. Taking this tack allowed Federal Reserve

officials to provide a valid description of monetary policy’s influence on the longer-term average

values of interest rates. This approach nevertheless sidestepped the reality that, over the short

and medium run, monetary policy bears heavily on how short-term nominal interest rates behave

in relation to expected inflation—and it is this horizon to which forward guidance, of the modern

type, pertains.

Policymakers in this earlier era refrained from comment about how interest rates

would behave over this horizon, and so they rarely gave bona fide forward guidance.

The analysis in this paper also shows that, from the late 1970s onward, although numerous

improvements occurred in policymaker communications about future monetary policy, these

innovations largely fell into the category of providing greater clarity about the horizon over

which policymakers hoped to reach their longer-term economic objectives—and did not involve

overt indications about future values of the policy rate. By the early 1990s, however, Federal

Reserve officials had become more comfortable with giving their public descriptions of

monetary policy decisions and strategy in terms of the setting of short-term interest rates.

Furthermore—and well before the range of variation of short-term rates was very close to the

ELB—their accounts now came to acknowledge explicitly the benefits of a situation in which

policymakers influenced longer-term interest rates by shaping market expectations of future

short-term interest rates. Even in this period, however, Federal Reserve officialdom largely

continued to imply that it was the responsibility of outside commentators, and not of

policymakers, to give public predictions concerning short-term interest rates. In this situation,

the onus was placed on the private sector to make inferences regarding the FOMC’s reaction

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This concern included a wish to avoid the possibility that the provision of guidance might be perceived as

amounting to a reversion to a policy (similar to that seen through 1951) of rigid pegging of interest rates—and so as

constituting a move away from adjusting the policy rate in response to the economic outlook.

Because so much medium-term variation in short-term nominal interest rates has to do with factors other than

expected inflation, many practical discussions of the Fisher relationship have treated that relationship as relevant

primarily for the analysis of the behavior of longer-term interest rates. Over long periods, however, even short-term

nominal interest rates should be closely related to expected inflation, as already indicated.

This shift culminated in the FOMC’s well-known move, in 1994, to making same-day announcements of its

decisions concerning the target federal funds rate.

function, in the absence of explicit official guidance on the matter. Nevertheless, and especially

at the end of the 1990s, the FOMC did on occasion provide very short-term forward guidance by

including, in its postmeeting statement, indications of its likely next-meeting policy decision.

is in the wake of this increased receptiveness on the part of policymakers toward discussion by

themselves of the likely values of future policy rates that forward guidance emerged as a policy

tool in the early years of the twenty-first century.

This paper’s analysis of the emergence of forward guidance as a policy tool will concentrate on

guidance concerning the federal funds rate.

Otherwise, no attempt will be made to distinguish

(along the lines of Campbell, Evans, Fisher, and Justiniano, 2012) between different possible

types of forward guidance. In particular, something not explored below is whether, in

articulating and clarifying the likely future policy rate path, forward guidance is meant to reshape

expectations regarding how near Federal Reserve will get to its goals in the medium term.

The rest of this paper provides details and documentation concerning the findings just described.

Section 2 discusses the building blocks of forward guidance—the two analytical premises,

mentioned above, regarding longer-term interest rates—and the fact that they were widely

accepted in U.S. policy analysis by the 1950s. With regard to forward guidance-type policies,

Sections 3, 4, and 5 discuss the attitude taken during the tenures (as head of the Federal Reserve

Board and FOMC) of William McChesney Martin Jr. (Section 3), Arthur Burns (Section 4), and

William Miller and Paul Volcker (Section 5). Section 6 discusses the gradual shift to an embrace

of forward guidance that occurred during the tenure of Alan Greenspan as Federal Reserve chair.

Section 7 offers some concluding observations.

2. The building blocks of forward guidance

Two analytical premises form key building blocks for a policy of forward guidance. These

premises are (i) that longer-term interest rates importantly influence private-sector spending

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The analysis is therefore basically consistent with a remark by Steinsson (2019) that in a “broader sense, forward

guidance has been a critical part of virtually every FOMC statement since 1999.” See also Lunsford (2020), who

focuses on forms of forward guidance provided by the FOMC in the period since early 2000. As these authors

classify descriptions of the economic outlook—not accompanied by an articulation of the likely accompanying

monetary policy settings—as forward guidance, they have a broader conception of guidance than that used below.

Concentrating on forward guidance regarding the federal funds rate is not very restrictive, in view of this paper’s

concentration on the period before 2003. When the Federal Reserve in this era did devote considerable attention to

quantitative tools (such as during its Operation Twist policy of the early 1960s and the period, from 1979 to 1982, of

operating procedures centered on the setting of nonborrowed reserves), these tools were varied primarily with a view

to altering near-term monetary and financial conditions, rather than (as occurs under forward guidance) affecting

expectations of conditions prevailing in the medium term.

decisions, and (ii) that expectations regarding the path of short-term interest rates are a key factor

driving longer-term interest rates. The objective of this section is simply to make clear that,

however new forward guidance may be as a policy tool, the acceptance of these two premises is

of many decades’ standing in monetary policy discussions.

Laidler (1989, p. 35) specifically identified with the advent of Keynesian economics the position

that long-term interest rates are key rates driving spending behavior. Consistent with Laidler’s

attribution, that position was strongly advocated by John Maynard Keynes in the 1930s,

especially in Keynes (1930).

However, an emphasis on the link between long-term rates and

private-sector spending decisions predated the 1930s. For example, Alfred Marshall (1923, p.

78), in commenting on how matters stood in the United Kingdom, observed that major firms’

source of long-term financing came not from commercial banks but from the issuance of

corporate bonds.

Over the century since Marshall wrote, it has remained a mainstay of

monetary policy discussions that—of the various open-market and administered interest rates

seen in the economy—those pertaining to longer-term loans are certainly important for private-

sector spending decisions.

This is the case especially in the case of the United States, which

traditionally has had household and corporate borrowing rates that are quite closely keyed to the

yields prevailing in longer-term securities markets.

One reflection of this situation was a 1979

statement by Paul Volcker, in remarks made in his confirmation hearings, that “the basic point

[is] that the most important interest rates in this context are probably longer-term interest

rates.”

The second building block of forward guidance is the premise that longer-term rates are partly

composed of the expected path of short-term rates and that, furthermore, this expected path is not

exogenously fixed: instead, the expected path responds endogenously to information provided in

the current period about the likely course of short-term rates. This premise is, of course,

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See also Levin, López-Salido, Nelson, and Yun (2010, p. 148).

The notion could also be found in the business press of the time. For example, in 1931 a U.K. newspaper reported

on a commentary by the Federation of British Industries that had stated that an “acceleration in the fall of the long-

term rate of interest… could do much to smooth the way of revival by encouraging the flow of funds into productive

investment” (Yorkshire Post, 1931).

Then, as now, corporate bond rates were accepted as being linked to rates on longer-term government securities.

This is true, to some extent, even in the 1930s and 1940s—decades in which doubts were widely expressed about

the effectiveness of monetary policy. Many of those who, in this period, cast doubt on the strength of the interest

elasticity of aggregate demand tended to accept that longer-term interest rates might have at least some importance

for investment spending. For a brief discussion of this point, see Friedman and Schwartz (1963, p. 700).

Rates facing both households and businesses matter, of course, as interest rates bear not only on firms’ investment

expenditures but also on households’ decisions concerning consumption.

From Volcker’s testimony of July 30, 1979, in Committee on Banking, Housing, and Urban Affairs, U.S. Senate

(1979, p. 19).

basically a corollary of the expectations theory of the term structure of interest rates. That theory

would be formalized by Hicks (1946, pp. 142150) and others. Even before this formalization,

however, a rudimentary version of the expectations theory was widely used in economic

discussions.

Indeed, the expectations theory underlay Keynes’ (1930) recommendation of

managing longer-term interest rates through short-term interest rate (Bank rate) policy.

In his

observation that varying Bank rate and giving related disclosures about monetary policy

provided value in “throwing new light, for example, on the policy and intentions of the currency

authority,” and in advocating these steps as a means of steering longer-term interest rates,

Keynes was essentially making a recommendation of a policy of forward guidance.

Subsequently, Keynes (1936) would become disillusioned with forward guidance, contending

instead that the expected path of short-term rates might become inert and, therefore, both that

path and the long-term rate itself would be rendered unresponsive to the authorities’ policies

regarding short-term interest rates.

Indeed, that pessimism about the capacity of short-term

interest rate policy to affect longer-term rates helped underpin a policy that Keynes (1936, p.

206) recommended—one that was, during the 1940s, followed by many central banks (including

the Federal Reserve, as discussed in the next section)—of managing long-term rates via central-

bank operations in longer-maturity government debt markets.

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More generally, that the long-term rate responded to short-term rate movements was a commonplace observation

in financial discussions. For example, a U.K. newspaper report in May 1931 (Daily Mail, 1931) opened by

remarking “The Bank Rate was today reduced from 3 to 2½ percent by the directors of the Bank of England. As a

result[,] gilt-edged securities showed a rise in prices.” The response of bond rates was clearly indicated as partly

involving an expectations channel: “If the present Bank Rate is maintained for any length of time, however, a further

general rise may be anticipated in the prices of government stocks.” (“Government stocks” and “gilt-edged

securities” were both U.K. nomenclature at the time for long-term government bonds.)

Note that this recommendation was made before effective lower bound (ELB) conditions on the short-term

interest rate became pressing in the United Kingdom. This fact illustrates the point that, while forward guidance is

often specifically associated with the ELB and seen as a tool to be deployed in ELB conditions (see English, López-

Salido, and Tetlow, 2015, Boneva, Harrison, and Waldron, 2018, and many of the references cited in Section I



above), the expectations channel on which it rests is not exclusive to ELB conditions, and forward guidance could

contribute to stabilization policy when the short-term rate is well away from the ELB.

See Keynes (1930, Volume 1, p. 202). One commentary that stressed this aspect of Keynes’ (1930) suggestions

was Meltzer (1983, p. 9; p. 144 of 1989 version). Meltzer noted that, in Keynes (1930), “the relevant rate for

investment [spending] is the long-term rate [which] responds very little to changes in Bank rate that are perceived to

be transitory”—a property that implies that a sizable response of the long-term rate requires an indication by the

authorities that a change in Bank rate will be persistent.

See, for example, Keynes (1936, pp. 202203, 207208). Culbertson (1957, p. 486) provided a particularly clear-

cut statement of the fact that, in Keynes (1936), Keynes abandoned the expectations theory of the term structure as a

basis both for understanding longer-term interest-rate behavior and for making monetary policy prescriptions.

Keynes (1930, Volume 2, p. 371) had already recommended this policy to back up forward guidance in conditions

of deep economic downturns. He appeared to favor forward guidance as the sole means of managing long-term

rates outside these conditions. (On this point, see especially the 1931 Keynes statement quoted in Tily, 2007, p. 57.)

However, not only did the U.S. authorities become disillusioned with this policy of administering

the long-term bond rate, but, also, the negative judgment by Keynes (1936)—that the market’s

determination of long-term rates was prone to be disconnected from the authorities’ policy

regarding the short-term interest rate—became viewed as not very widely applicable.

Instead,

the expectations theory was accepted in the postwar period as an important element in

understanding how longer-term interest rates were determined when those rates were allowed to

be driven by market forces. Along these lines, in a 1957 Congressional hearing, Senator Paul

Douglas remarked to Federal Reserve Chairman Martin and to Martin’s aide, Winfield Riefler,

that Riefler’s (1930) vintage study of U.S. financial markets had found that “changes in the

short-time [sic] rate had an effect on the long-time rate.”

Douglas implied, and his interlocutors

appeared to assent, that this state of affairs remained true in the 1950s.

The building blocks of forward guidance therefore acquired wide acceptance in monetary policy

circles. From an early stage after the end of World War II, the two key premises that would

provide the rationale for guidance had been embraced. Why, then, was forward guidance not

adopted as a monetary policy tool in the United States until the 2000s? The rest of this paper

explores this question. It will do so by documenting how, from the 1950s and into the 1990s,

Federal Reserve policymakers resisted the usage of forward guidance as a policy tool, and by

examining the reasons for this opposition.

3. The Martin Federal Reserve, 19511970—“You See It As We Do It”

During the period from 1942 to 1951, the Federal Reserve enforced a peg (upper limit) on the

market rate prevailing on longer-term U.S. government securities. In particular, the Federal

Reserve authorities explicitly indicated that they aimed to secure a peg of 2.5 percent on long-

term Treasury securities.

In addition, until the late 1940s certain shorter-maturity rates were

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That is, this notion did not gain lasting acceptance in U.S. policy circles, even though other Keynesian ideas were

integrated into policymakers’ thinking.

From a hearing held on March 19, 1957, in Committee on Banking and Currency, U.S. Senate (1957, p. 274).

Along the same lines, in economic research that appeared during this period, Duesenberry (1958, p. 317) affirmed

the expectations channel. Specifically, Duesenberry noted that the scenario sketched in Keynes (1936) involved the

expected path of interest rates, and hence longer-term interest rates, being invariant, on net, to measures that altered

the short-term interest rate today, and he observed that this adverse result would not occur in an environment in

which “a rise in rates led to an expectation of a further rise” and if (contrary to Keynes, 1936) a reduction in the rate

today similarly led, on net, to a shift down in the path of current and expected short-term rates.

Chaurushiya and Kuttner (2003, p. 9) stated that “the caps on long-term interest rates were never formally

announced.” This statement was incorrect. Indeed, one of the references that Chaurushiya and Kuttner (2003)

cited—Friedman and Schwartz (1963)—relied almost completely on public sources in its account of postwar

Federal Reserve policy yet was able to point to official Federal Reserve publications (such as Board of Governors of

the Federal Reserve System, 1946, p. 7) that were numerically explicit with regard to the peg of the long-term

likewise subject to officially enforced pegs. Although the policy of fixing longer-term interest

rates was introduced during wartime, Federal Reserve officials in the mid-1940s stated that it

was also a desirable arrangement for postwar conditions—including for the period beyond the

transition from a war-mobilized economy.

Consistent with this posture, the Federal Reserve’s

public and open-ended commitment to a peg continued beyond the end of World War II.

It was nevertheless the case, even in the early postwar years, that there was little of what today

would be called “forward guidance” on the part of senior figures at the Federal Reserve, beyond

public affirmations of the pegged security prices and of the ongoing nature of the pegging policy.

Federal Reserve officials were hesitant to engage in public discussion of likely future policy

actions—a hesitancy brought out in the May 1946 remark by Allen Sproul, president of the

Federal Reserve Bank of New York (and vice chair of the FOMC): “And now I have driven

myself into a corner where I must say something about restraint on further credit expansion,

which is the area in which I have some direct responsibility and, therefore, the area where it is

most difficult to make public pronouncements.”

Of course, during the era of the peg, discussion of future policy could be considered redundant—

as the Federal Reserve’s public commitment to an indefinite peg of longer-term securities rates

amounted to a central commitment regarding future policy—as well as being potentially

counterproductive—as expanding on the subject of future monetary policy might be perceived as

encouraging doubt about the durability of the pegging arrangements. It is likely, however, that

there were further factors that made policymakers hesitant between 1945 and 1951 (when the

pegging policy was terminated) to elaborate on the setting of future policy. Most notably, they

clearly wanted to maintain areas of flexibility in the settings of Federal Reserve policy other than

those specifically concerning the long-term rate. In particular, they likely wished to keep their

options open with regard to the permanence of other aspects of the pegging arrangements (such

as the pegs for shorter maturities) as well as not to send signals about the setting of policy tools,

such as reserve requirements, that could be varied in the context of the ongoing interest-rate

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government bond rate (see Friedman and Schwartz, 1963, p. 578). Another instance in which the Federal Reserve

made an official statement of the pegged rates consisted of the following numerically specific remarks that Federal

Reserve Chairman Marriner Eccles gave in Congressional testimony in early 1947: “To maintain a stable market for

government securities, the Federal Reserve System adopted a policy of maintaining the level of interest rates. The

supported rates ranged from 2½ percent on long-term securities… down to ⅞ percent on one-year certificates. In

addition, [rates on] 90-day Treasury bills… were kept at ⅜ percent.” (Testimony of March 4, 1947, in Committee

on Banking and Currency, House of Representatives, 1947, p. 20.)

For such statements by officials, see, for example, Goldenweiser (1945, p. 14).

Sproul (1946, p. 2948).

peg.

These aspects of the monetary policy setup did indeed prove subject to alteration during

the period in which the peg of the long-term rate remained in force: the ceilings on shorter-term

rates were dropped, and reserve requirements were increased, in the years prior to 1951.

The subject of future monetary policy acquired more content once the Federal Reserve/Treasury

Accord of 1951 formally ended the commitment by monetary policy to a bond-rate peg. In the

course of congressional testimony given in mid-1953, William McChesney Martin Jr. (Federal

Reserve Chairman from 1951 to 1970) noted the fact that, consistent with the new policy

environment, the Federal Reserve had recently discontinued its regular interventions in longer-

term securities markets. In these comments, Martin implied not only that the long-term rate was

no longer a policy rate, but that he would also not make predictions regarding that rate: “I simply

would not comment on [bond] prices…. I will not make any comment on prices.”

From the perspective of forward guidance, what is notable is that Martin was also reluctant, not

only in 1953 but also throughout his many further years as Federal Reserve chair, to comment on

future short-term interest rates.

This official reticence about referring to the future course of short-term rates occurred despite the

fact that short-term rates remained, in essence, determined by the Federal Reserve in the post-

Accord period. Although the Federal Reserve had withdrawn from direct management of longer-

term rates, it continued to follow open-market and discount-rate policies that were consciously

intended to set short-term rates. As Meltzer (2009, p. 6) observed, however, in public the

Federal Reserve in the early post-Accord years was not transparent about the fact that it was

continuing to determine short-term market interest rates.

To understand the reason for this oblique approach, it is worthwhile going back to the

aforementioned 1946 speech by Sproul and 1953 testimony by Martin. In particular, Sproul

(1946, p. 2949) observed that Federal Reserve decisions should be guided by the need “to

discharge our responsibility for promoting economic stability,” while Martin similarly testified

that part of the purpose of the Federal Reserve Act was to create an agency that minimized

——————————————————————————————————————————

Conversely, when Federal Reserve officials did make public indications or prescriptions regarding future policy, it

was predominantly against the backdrop of an assumed maintenance of the pegging policy. For example, Sproul

(1946, p. 2949) urged that the rate of commercial bank credit growth be reduced in future periods through

encouragement of the banks to exercise voluntary restraint and through Federal Reserve actions to prevent declines

in market interest rates (that is, to keep those rates closer to the ceilings implied by the pegs).

From Martin’s testimony of May 5, 1953, in Committee on Banking and Currency, House of Representatives

(1953, p. 11). (Essentially all of the hearings volumes cited in this paper are available on the internet in digitized

form, with many of them downloadable at the Federal Reserve Bank of St. Louis’ FRASER site.)

booms and busts (Committee on Banking and Currency, House of Representatives, 1953, p. 12).

The macroeconomic-stability goal assigned to the Federal Reserve by statute in turn guided

policymakers’ attitude during the 1950s toward their setting of short-term rates, as well as their

public discussions of those settings. In contrast to some of the thinking that had underpinned the

pegging policy, Martin was of the view that aggregate demand was notably interest-elastic and

that the level of interest rates consistent with delivering economic stability varied over time.

Against this backdrop, a distinction between two interest-rate policies acquired particular

prominence: that between the pre-1951 policy of pegging (that is, making constant or imposing

an upper bound on) certain interest rates, and the post-Accord policy of varying the short-term

rate in a manner designed to stabilize economic activity. The latter policy amounted to a

reaction function involving temporarily fixed interest rates, with the numerical targets for short-

term interest rates being adjusted in response to economic developments. As stressed by Ahearn

(1963, pp. 3738), Federal Reserve officials believed that being forthcoming about monetary

policy’s aims for short-term interest rates at any particular point in time risked being put under

pressure not to alter the targeted rate—and so having the policy degenerate into one of pegging

short-term interest rates. The Federal Reserve under Chairman Martin evidently had limited

confidence in the chances of successfully communicating the distinction between a short-term

interest-rate peg and a reaction function regarding the rate, and so they refrained from being up-

front about the fact that they managed short-term interest rates.

Nonetheless, in the course of his tenure, Martin made many statements that were tantamount to

acknowledging that short-term market interest rates were determined by the Federal Reserve.

For example, in testimony of March 19, 1957, he remarked that the FOMC had been “letting the

forces of supply and demand operate” on interest rates.

Martin went on to acknowledge that

these forces included a Federal Reserve decision not to let the supply of savings be augmented

by the creation of additional credit.

And when asked, “We have a managed money market, do

we not?,” Martin replied, “We do.”

Similarly, in testimony given the following August, Martin

observed that the FOMC had permitted upward pressures on interest rates arising from market

forces to make themselves felt on rates.

By acknowledging that alternative Federal Reserve

policies could have prevented short-term interest rates from rising and that the Federal Reserve

——————————————————————————————————————————

For example, Martin affirmed the interest elasticity of aggregate demand in his testimony of August 16, 1957, in

Committee on Finance, U.S. Senate (1957, pp. 1425, 1427).

In Committee on Banking and Currency, U.S. Senate (1957, p. 274).

In Committee on Banking and Currency, U.S. Senate (1957, p. 275).

In Committee on Banking and Currency, U.S. Senate (1957, p. 275). Martin’s questioner, Senator Joseph Clark

(Pennsylvania), immediately replied, “And you are the manager.”

August 16, 1957, testimony, in Committee on Finance, U.S. Senate (1957, pp. 14261427).

had permitted and managed the rise that had occurred during 1957, Martin was, in these

discussions, in effect granting the fact of the FOMC’s usage of an interest-rate instrument.

In contrast to his acknowledgment (albeit in an indirect way) that the Federal Reserve set short-

term interest rates, Martin was opposed to giving indications of the likely path of short-term

rates. Indeed, when he began to do this in his August 1957 congressional testimony, Martin

corrected himself: “I am inclined to think that we may have a leveling-out process here, and we

may find that interest rates will stabilize and may even decline. But if that is a forecast—I do not

want to make a forecast.”

Martin was strongly opposed to making macroeconomic forecasts in

general and predictions about short-term interest rates in particular—a posture summarized in a

remark he made in September 1967: “I try to keep away from this prediction thing.”

Likewise,

when opening a speech in 1961, Martin observed: “At the outset I want to make clear that I am

not making any business predictions nor even forecasting what the level of interest rates may be

a year from now.”

And in a 1967 hearing Martin told a questioner: “I can’t make any

predictions about interest rates, obviously.”

Martin outlined the reasons for his aversion to giving interest-rate predictions in remarks he

made in December 1965. “I have learned that a person in the position that I presently occupy

can’t make predictions about interest rates without tending to change the given monetary

operational situation merely by the statement. It is one of the difficulties that a person holding

this position has. I have, on a number of occasions, tried to discuss in a perfectly open and

general way what was going to happen, and the result was I changed the whole course of the

market. And I don’t think I ought to be making predictions.”

Another remark that was

revealing about Martin’s position on this matter was one he relayed in early 1968. When asked

about prospects for short-term interest rates, he gave a reply that encompassed yields at both

short and longer maturities: “The precise levels of these interest rates you cannot make an

——————————————————————————————————————————

August 16, 1957, testimony, in Committee on Finance, U.S. Senate (1957, p. 1430).

September 14, 1967, testimony, in Committee on Ways and Means, House of Representatives (1967a, p. 705).

Martin (1961, p. 1747).

From Martin’s testimony of November 29, 1967, in Committee on Ways and Means, House of Representatives

(1967b, p. 46). (Here and in what follows, punctuation has been added to quotations when the original published

transcripts of the hearings were clearly missing punctuation.)

From Martin’s testimony of December 13, 1965, in Joint Economic Committee, U.S. Congress (1966, p. 65). In

addition to declining to discuss future monetary policy moves, Martin was reluctant to indicate likely Federal

Reserve policy responses to hypothetical situations. For example, when asked if the Federal Reserve Board would

raise the discount rate in the event of a pronounced movement of funds from the United States to Europe, Martin

replied, “I wouldn’t make any prediction of what we would do.” (Testimony of July 21, 1965, in Committee on

Banking and Currency, U.S. Senate, 1965, p. 59.)

accurate forecast on, because here you have demand and supply pressures that are

imponderable.”

Taken together, these 1965 and 1968 statements indicate that Martin’s aversion to making

interest-rate forecasts reflected both the fear that markets would overreact to announcements and

the fragility of the interest rate forecasts given in those announcements. Martin was highly

aware that public discussion on his part of the interest-rate outlook would alter U.S. financial

conditions. In principle, in light of the emphasis placed, even in the 1960s, by policymakers on

the long-term interest rate as a driver of aggregate demand, the ability to reinforce actual policy

moves through a process of foreshadowing likely future moves might have been perceived as

advantageous. But Martin believed that doing this was likely in practice to be counterproductive,

as he thought that the market reaction to such discussion was prone to be excessive (“I changed

the whole course of the market”). This basis for refraining from providing forward guidance was

reinforced by Martin’s conviction that policymakers’ assessments of the appropriate level of

future short-term interest rates were, in any event, necessarily tentative and highly uncertain—a

state of affairs that implied that an articulation of these assessments was of questionable value.

These reservations about adopting forward guidance were also voiced by Governor Mitchell,

Martin’s FOMC and Federal Reserve Board colleague, in a 1966 speech. On that occasion,

Mitchell made the statement—quoted in the introduction above—that monetary policy decisions

were announced without accompanying signals of future policy moves. It was desirable that this

was the case, Mitchell suggested, as the “appropriate course for monetary policy” was too hard

to predict.

Therefore, he explained, the Federal Reserve covered only its individual period-by-

period decisions in its monetary policy announcements: “Over the years the System has

developed a method of communicating with the market which is as straightforward, accurate and

objective as quantitative relationships can make it. It is a ‘you see it as we do it’ policy.”

Guided by thinking along these lines, Chairman Martin limited his description of the likely

course of interest rates to longer-term influences. For one thing, he was willing to cite fiscal

policy as an influence on short- and long-term interest rates on the ground that, by putting

upward pressure on the demand for funds and on aggregate demand, budget deficits made the

interest-rate values consistent with full employment and price stability higher than otherwise.

——————————————————————————————————————————

From Martin’s testimony of January 22, 1968, in Committee on Ways and Means, House of Representatives

(1968, p. 77).

Mitchell (1966a, p. 3; p. 398 of 1971 printed version). See also Mitchell (1966b, p. 8).

Mitchell (1966a, p. 2; p. 398 of 1971 printed version). See also Mitchell (1966b, p. 7).

For example, in 1968 congressional testimony, Martin remarked: “can I make one further

comment on interest rates?… I may not have given you much hope that interest rates are going to

come down. I cannot be sure of that. I have given you my conviction that there is a likelihood

of it, a possibility of it, if we reduce this budget deficit to more manageable proportions.”

The second longer-term influence was one Martin referenced repeatedly in the late 1960s, after

inflation had picked up in the United States. This influence involved the Fisher relationship

between expected inflation and interest rates. In a formulation that would be repeated by his

successors, Martin emphasized that the overall increase in nominal interest rates in the United

States in the course of the 1960s reflected in large part the fact that monetary policy had, on

average, been too loose.

The tight monetary policy in which the Federal Reserve engaged,

starting in late 1968 and maintained in 1969, was associated with higher interest rates. Martin,

however, justified the tightening in part on the basis that it would lead ultimately to lower

interest rates: “it is clear what we need to do to get interest rates back down to more sensible

levels. We must follow economic stabilization policies that bring inflation under control.”

Acknowledgment of these longer-term drivers of interest rates did not really constitute forward

guidance, as they constituted (i) a nonmonetary factor—fiscal policy—affecting the general level

of interest rates and (ii) a monetary policy influence on the longer-term average of nominal

interest rates. In contrast, forward guidance of the modern type refers to the short- and medium-

term influence of monetary policy on the course of real and nominal short-term interest rates.

In 1969, however, Martin did modify his communications practices somewhat by providing a

degree of guidance: an indication that the existing stance of monetary policy would continue.

The background for this change was that, as he noted in February 1969, “we have had quite a

credibility gap as to whether we meant business at the Federal Reserve”—that is, whether the

Federal Reserve would maintain a restrictive monetary policy long enough to end inflation.

——————————————————————————————————————————

From Martin’s testimony of January 22, 1968, in Committee on Ways and Means, House of Representatives

(1968, p. 83). Martin indicated that the budget deficit’s effect that he was describing referred to a situation different

from one in which the Federal Reserve “totally ignore[d] its responsibility for fighting inflation [by] … just add[ing]

ad infinitum to the money supply.” He was therefore premising his comments on non-accommodation, by the

Federal Reserve, of the deficit—and so was referring to the upward pressure on equilibrium real interest rates arising

from the additional issuance of U.S. Treasury debt to the private sector.

See, especially, Martin’s testimony of March 25, 1969, in Joint Economic Committee (1969, pp. 810). See also

the discussion of this testimony in Meltzer (2009, p. 565).

From Martin’s testimony of March 25, 1969, in Committee on Banking and Currency, U.S. Senate (1969, p. 10).

From Martin’s testimony of February 26, 1969, in Joint Economic Committee (1969, p. 685).

In light of this situation, Martin wanted to convey the notion that the existing tight posture would

be continued long enough to secure conditions of price stability. He therefore took a different

approach from that he had followed during a previous tightening phase in 1957. On that

occasion, Martin had been noncommittal about the likely length of the period of restriction,

stating that he “would not want to forecast at all” whether tight money would continue.

1969, Martin modified his approach. When asked to comment on forecasts for inflation and

unemployment made by academic economists, Martin reaffirmed that he “avoided making any

forecasts per se,” but he added: “I think that if we move intelligently and persistently along the

course we are pursuing, we can—to use the phrase I have repeated over and over here—

disinflate without deflating.”

So it remained the case that Martin was reluctant to make

numerical predictions concerning economic outcomes or to talk specifically about the medium-

term implications for interest rates likely associated with monetary policy decisions. But it was

also the case that concerns about the FOMC’s credibility had made him more amenable to being

overt in expressing the point that the existing stance of monetary policy would be continued until

it was clear that the Federal Reserve’s macroeconomic objectives were being met.

4. The Burns Federal Reserve, 19701978

Arthur Burns (Federal Reserve chair from 1970 to1978) was consistently opposed to forward

guidance. Although, as shown below, he was willing to talk in general terms about the Federal

Open Market Committee’s strategy for achieving its macroeconomic objectives, Burns was, like

his predecessor, averse to describing the likely implications of this strategy for the course of

interest rates, other than the longer-term implications associated with the Fisher effect. He took

policy choices regarding short-term interest rates at Federal Reserve policy meetings as

pertaining to the immediate policy action and not to future policy.

Burns saw public

commentary on his part regarding future short-term rates as being undesirable because he

believed that this would preempt forthcoming FOMC decisions. In addition, even though he saw

longer-term interest rates as key for aggregate demand, Burns was against moving financial

markets by remarking on prospective FOMC decisions.

——————————————————————————————————————————

From testimony of March 19, 1957, in Committee on Banking and Currency, U.S. Senate (1957, p. 274).

From Martin’s testimony of February 26, 1969, in Joint Economic Committee (1969, p. 685).

In testimony a month later, Martin reaffirmed this point, stressing that restrictive monetary policy needed to

“continue… long enough to be sure that a resurgence of excess demand and strong cost and price pressures does not

occur.” (Testimony of March 25, 1969, in Committee on Banking and Currency, U.S. Senate, 1969, p. 10.)

As will be seen, he regarded this as the case for both Federal Reserve Board decisions regarding the discount rate

and FOMC decisions regarding the federal funds rate. At the time, discount rate adjustments were made at meetings

of the Board governors—and so were on a different schedule from federal funds rate decisions at FOMC meetings.

Burns’ attitude regarding this matter was evident in testimony he gave less than a week after

becoming chair. Speaking at a hearing of the House of Representative’s Committee on Banking

and Currency, Burns remarked that he hoped “I might be wise enough, prudent enough, not to

make any such premature announcement to the marketplace. If and when the Board decides to

act, it should act, and I think it would be wrong, even immoral, for the Chairman or other

members of the Board to give any clues to the market about prospective action.”

A couple of weeks later, at a Joint Economic Committee hearing, asked what evidence he needed

to see “before you begin to ease up on credit,” Burns replied: “Senator, you are putting a very

difficult question to me. I am now in the central banking business. And by tradition—and I

think the tradition has arisen out of necessity—there are some questions on which central

bankers cannot speak with great freedom. And the reason is that if they do, they may have a

very unhappy effect on markets. The capital market may swing, and money will be made and

money will be lost. There is a great moral responsibility here.”

In response to a question later

in the hearing, “Are we likely to see a quick decrease in the interest rate level in this country?,”

Burns replied: “I do not think I should try to predict that.”

In addition to eschewing the articulation of a prediction of the path of the interest rates, Burns

also indicated an unwillingness to forecast the associated path of monetary growth, and for

similar reasons: “any projections we make about monetary aggregates will go on the [news]

wire, all over the world. And they may rock, one way or another, the financial market[s]. And

money may be made by the millions by people who have no right to make it. And—what

worries me more—innocent people may lose.”

A year later, Burns displayed a continuing unwillingness to comment on likely Federal Reserve

policy responses, whether these were cast in in terms of interest rates or in terms of the money

stock. Asked if, in the event of a large fiscal expansion, one “might well expect to find a

counter-reaction in the Federal Reserve Board with respect to the money supply and interest

rates,” Burns replied: “The question is much too hypothetical, Senator… There are so many

developments that one can’t foresee that I think it would be entirely unwise for me to try to

project what we might do in the kind of circumstances which you envisage.”

——————————————————————————————————————————

From Burns’ testimony of February 6, 1970, in Committee on Banking and Currency, House of Representatives

(1970, p. 266).

From Burns’ testimony of February 18, 1970, in Joint Economic Committee (1970, p. 152).

From Burns’ testimony of February 18, 1970, in Joint Economic Committee (1970, p. 171).

From Burns’ testimony of February 18, 1970, in Joint Economic Committee (1970, p. 183).

From Burns’ testimony of February 19, 1971, testimony, in Joint Economic Committee (1971, p. 264).

In 1970, the FOMC allowed interest rates to decline. At the time, it believed that this was an

adjustment consistent with continued moderate restraint of aggregate demand: Burns expressed

confidence in April “that we making progress in the fight against inflation in the United States,

and that interest rates have already passed their peak.”

In retrospect, however, the FOMC is

believed to have eased excessively in the course of 1970, helping create the conditions that

generated the mid-decade breakout of inflation (see especially Orphanides, 2003, pp. 657658).

The expansionary direction that the FOMC took in 1970 was bolstered by further easing of

monetary policy during 1971—a year in which Burns was also an enthusiastic supporter of the

Nixon Administration’s imposition of national wage and price controls. Retrospective

judgments are predominantly that, in the years from 1970 to 1972, the FOMC’s posture was

excessively loose. For the purposes of this paper, however, it is important to keep in mind that

throughout 1971 and 1972, as in 1970, Burns thought that he was pursuing a policy consistent

with ongoing disinflation and the avoidance of economic overheating.

This fact provides an

understanding of what he said over this period about the interest-rate path. Continuing his

previous practice, he refrained from indicating the likely near-term course of monetary policy,

but, like Chairman Martin before him, he was willing to say that, over a longer horizon, nominal

interest rates would follow inflation—which Burns erroneously believed was, under current

policy settings, on course to converge to a low rate.

When, therefore, at a November 1971 hearing, the question was asked, “Do you feel that the

trend in interest rates will be downward, or stabilized, or upward, Dr. Burns, in the future,

foreseeable future?,” Burns replied: “I feel, as I have tried to make clear…, that if the present

anti-inflation policy succeeds, the trend of interest rates will probably be downward.” He added:

“I would like to see them be a good deal lower, provided supply and demand conditions justified

lower interest rates.”

After inflation broke out in 1973 and remained high, the FOMC, which had already begun

raising the federal funds rate in 1972, engaged in a prolonged tightening of monetary policy.

During this tightening phase, Burns found it beneficial, as Martin had in 1969, to make clear that

the firmness of monetary policy would not be ended precipitously. In relaying this position,

Burns, unusually, engaged in a modest amount of forward guidance regarding interest rates. “As

——————————————————————————————————————————

Burns (1970, pp. 45). This was really an account of the FOMC’s policy stance, rather than forward guidance.

See Romer and Romer (2002) and Nelson (2005) for detailed discussions of the conceptual framework to which

Burns subscribed during this period.

From Burns’ testimony of November 1, 1971, in Committee on Banking and Currency, House of Representatives

(1971, p. 461).

this year’s experience has again indicated, a serious effort to moderate the growth of money and

credit during a period of burgeoning credit demand results in higher interest rates—particularly

on short-term loans,” Burns remarked in a May 1974 speech. “Troublesome though this rise in

interest rates may be, it must for a time be tolerated.” He indicated that attempts by the FOMC,

instead, to lower interest rates immediately would ultimately generate higher rates via the

operation of the Fisher relationship.

Burns had therefore shown himself to be amenable to providing some guidance concerning the

FOMC’s settings of monetary policy. He objected strongly, however, in early 1975 when

Congress was poised to pass a resolution that would require the FOMC to enumerate targets for

monetary growth and report on its progress in achieving them. Notably, Burns was also critical

of an additional clause in the resolution—not necessarily tied to monetary targeting—mandating

that the Federal Reserve lay out publicly its plans for monetary policy. He remarked: “Finally,

the Board objects to the last paragraph of Resolution 18, which calls for semiannual reports to

the Congress by the Federal Reserve of its plans for future monetary policy. Such a requirement

could limit the flexibility of monetary policy in responding to unexpected developments, and it

could undermine the capacity of the Federal Reserve to exercise its best judgment… [It] would

also provide opportunities for sophisticated market participants to gain at the expense of others

by using the information they would receive on the anticipated course of monetary policy.”

Burns therefore opposed disclosure of monetary policy plans both because he viewed such

communication as preventing flexibility in future FOMC deliberations, and because he continued

to believe that the information provided publicly about monetary policy should be limited to

actual decisions.

Over Burns’ objections, however, targets for monetary growth—which the FOMC had been

following in some form since his tenure began—became something on which he regularly

reported to Congress. From the perspective of forward guidance, however, the resolution was

not particularly onerous in its requirement for disclosures of plans regarding monetary policy.

The monetary-growth target requirement formally did not require the Federal Reserve to be very

precise about future monetary policy. Under Burns, monetary targets were set for a year ahead,

but the FOMC voted on this target at every FOMC meeting within that year. This meant that, in

——————————————————————————————————————————

Burns (1974a, p. 9).

Testimony of February 25, 1975, to Committee on Banking, Housing and Urban Affairs, U.S. Senate (Burns,

1975, p. 154). Burns was commenting on a Senate draft of the resolution, designated Resolution 18. In the event,

the resolution in revised form was passed by both houses of Congress as Concurrent Resolution 133.

the course of the year to which the monetary target applied, it had the option of altering its target

growth rate for M1, for M2, or for both aggregates, at any FOMC meeting.

In practice, however, the Federal Reserve provided somewhat more concrete information

regarding its plans for coming years’ monetary policy than these limited formalities required.

First, the FOMC was inclined to avoid exercising its option of making changes to the monetary

growth target during the year. Second, Burns also elaborated on the FOMC’s projection of the

current year’s monetary growth rates by sketching the likely evolution of monetary targets

beyond that year. For example, in July 1977, Burns noted that the announced target pertained to

the year to mid-1978 but indicated that the FOMC aimed at “bringing the long-run growth of the

monetary aggregates down to rates compatible with general price stability.”

Burns added that if

the step-down in announced monetary targets continued at its existing pace, the target path for

monetary growth rates would continue to decline and reach rates consistent with price stability in

around the mid-1980s.

The 1975 formalization of monetary targeting had therefore made the

FOMC more forthcoming about its intended rates of monetary growth.

In this new environment, however, Burns remained resolute in rejecting the notion of

policymaker-provided interest-rate projections to accompany the monetary targets.

Consequently, although the formal introduction of monetary targets in 1975 was followed by the

provision by the FOMC of its intentions concerning monetary growth over the medium term, the

Committee gave no corresponding guidance concerning interest rates.

Of particular note in this connection is a written answer by Burns, in early 1976, to a

congressional question. In this reply, Burns indicated his continuing rejection of the suggestion

that policymakers should provide forecasts of interest rates. He had become reconciled to giving

regular testimony on monetary-growth targets but was poorly disposed to the idea of extending

reporting requirements to include policymaker projections of interest rates. “I believe it would

be both inappropriate and misleading for the Federal Reserve to express a view at these hearings

about the likely future course of interest rates. An announcement by the nation’s central bank of

its intentions or expectations about interest rates would be subject to misinterpretation, could

——————————————————————————————————————————

Burns had already made statements along these lines even before monetary targeting had become a

Congressionally-mandated policy. For example, he stated in mid-1974 (Burns, 1974b, p. 559): “We are determined

to reduce, over time, the rate of monetary and credit expansion to a pace consistent with a stable price level.”

Testimony by Arthur Burns of July 29, 1977, in Committee on Banking, Finance and Urban Affairs, U.S. House

of Representatives (Burns, 1977a, p. 727). This indication on Burns’ part was consistent with the 1975 resolution’s

requirement that the rate of long-run monetary growth should be that compatible with price stability. It was also

consistent with the Federal Reserve’s existing legislated mandate, which Burns took as entailing a price-stability

goal as well as an employment goal (see Burns, 1975, p. 153).

impair the effectiveness of monetary policy, and could have harmful consequences for the

economy and the nation.”

As one danger associated with such a practice, Burns cited the loss of prerogatives in future

decision periods that might be entailed if a projection was seen as a commitment: “Any

announcement of interest rate intentions or expectations by the Federal Reserve may lead many

borrowers and lenders to believe that the System could and in practice would guarantee

particular interest rate levels.”

This was undesirable, he contended, as the interest rates

appropriate for economic stabilization could not be predicted ahead of time: “efforts by the

Federal Reserve to sustain particular interest rates could result in inappropriate rates of growth in

bank reserves and money.” In this connection, Burns cited dangers in both directions:

inappropriately low interest rates, which would foster monetary and economic overheating, and

unduly high interest rates, which would instill an excessively tight policy stance.

This reservation—that a central bank might feel obliged to validate interest-rate forecasts, in the

face of those interest rates proving to be inappropriate for the achievement of macroeconomic

goals—was a recurring one in Federal Reserve officials’ statements through the 1990s. As will

be shown below, after Burns’ departure, it was a sentiment that continued to emanate from the

Federal Reserve under chairs Miller, Volcker, and Greenspan.

That posture contrasts with the attitude to forward guidance prevalent in the modern era. Two

aspects of the modern perspective on forward guidance are especially notable, because of their

divergence from the attitudes prevalent in prior decades. First, policymakers who have used

forward guidance have been comfortable in stating a point that previous eras’ policymakers had

suggested might be too difficult to relay in policy communications: that the forecast interest rate

path may well not be realized. For example, in testimony on February 29, 2012, Federal Reserve

chair Ben Bernanke stated that forward guidance “is a conditional policy. It says: ‘Based on

what we know now, this is where we think we are going to be.’ But, of course, if there is a

substantial change in the [economic] outlook, we would have to adjust [the funds rate path]

accordingly.”

Second, the result that financial markets might align asset prices with

policymakers’ forecast interest-rate path has been seen as a desirable outcome, rather than an

eventuality to be avoided. For example, Svensson (2015, p. 26) cited the requirement that

——————————————————————————————————————————

Burns (1976, p. 377). (The rendition of the quotation given here corrects a typographical error in the original

printed version, whose text gave the word “Revenue” instead of “Reserve.”)

Burns (1976, p. 377).

In Committee on Financial Services, House of Representatives (2012, p. 26).

“market expectations adjust to the policy rate path when it is published” as one criterion on

which to judge the credibility and success of forward guidance. In contrast, policymakers in the

pre-forward guidance era saw such a movement of asset prices as disorderly. This negative

attitude toward providing information that might move asset prices before a rate decision had

been formally made was, as noted above, voiced by Chairman Martin, but it was reiterated

during Burns’ tenure and by Burns’ successors.

During 1977, which proved to be his final full year as chair, Burns remained unconvinced of the

merits of forward guidance regarding interest rates. In March 1977, when asked by a legislator

whether he expected rates to rise over the next year and a half, Burns replied simply: “That is a

very difficult question to put to a central banker. Central bankers do not talk about things like

that.”

The following July, Burns gave a negative verdict on draft legislation that included a

requirement that Federal Reserve policymakers provide forecasts of the path of interest rates

over the coming year. “The provision calling for projections of interest rate levels for twelve

months ahead is particularly ill advised. Neither the Board nor the FOMC makes such estimates.

To be sure, some, if not all, members have more or less well-defined expectations about the

likely course of rates in coming months, but members of the Board and of the FOMC do not

discuss such expectations in public. Federal Reserve officials are extremely careful to avoid any

public comment that might suggest or imply some particular outlook for interest rates.”

Burns ended acerbically by remarking that the “capacity for mischief inherent in the interest-rate

provision is so apparent that I find its inclusion in the bill inexplicable.” This reproachful tone

was also evident when the subject of mandated interest-rate forecasts came up in the question-

and-answer portion of this testimony. In answer to a query, Burns indicated it was open to “very

extensive discussions about past interest rates, very extensive discussions about current interest

rates” and that he was particularly interested in talking about how the Fisher effect had led to

great differences in nominal interest rates across countries. However, he maintained that “you

will never get a forecast concerning interest rates out of me, under any circumstances, unless you

require it by law.” Indeed, Burns implied that, in the event that such a requirement did become

law (which it did not), he might step down as chair.

——————————————————————————————————————————

From Burns’ testimony of March 22, 1977, in Committee on the Budget, U.S. Senate (1977, p. 203).

Testimony of July 26, 1977, in Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives

(1977, p. 58). Also in Burns (1977b, p. 717).

Testimony of July 26, 1977, in Committee on Banking, Finance and Urban Affairs, House of Representatives

(1977, p. 68).

This negativity regarding forward guidance that Burns expressed throughout his tenure existed

despite his belief that longer-term interest rates were the key interest rates for spending. Why

did he resist forward guidance, which might reinforce the effect of monetary policy on longer-

term interest rates? One point worth noting is that Burns on occasion downplayed the effect of

monetary policy on longer-term rates. He stressed the impact of other influences—and, for a

while in 1975, when the term structure was particularly steep, he suggested that the effect of

changes in the federal funds rate on longer-term rates was negligible (see Nelson, 2005).

For the most part, however, Burns did grant that the Federal Reserve could affect longer-term

rates through an expectations channel, as well as by affecting current short-term rates. However,

his default position was to eschew trying to affect longer-term rates by foreshadowing future

FOMC interest-rate settings. As indicated above, he regarded making rate forecasts as

trespassing on the prerogatives of future policymakers. But, like Martin before him, he did not

think that the information, if conveyed, would prompt orderly and desirable market reactions.

On the contrary, Burns’ July 1977 testimony argued that FOMC announcements of interest-rate

forecasts would “rock financial markets.”

Burns also believed that the tentative character of Federal Reserve policymaker projections made

it undesirable to articulate them publicly: policymakers’ interest-rate expectations “might change

[after] a week or a month… and in any event might be mistaken.” “If we made specific

pronouncements about the future of interest rates,” Burns argued, “…[i]nappropriate and violent

changes of interest rates could take place and the economy suffer from the financial stability so

generated.”

Finally, as he contended that announcing forecasts of interest rates tended to

commit policymakers to those rates, Burns feared that forward guidance might push longer-term

interest rates away from policymakers’ hoped-for values over a longer period of time. In

particular, locking policymakers into what turned out to be an inappropriate short-term rate path

could lead to unintended shifts in the longer-term inflation rate, and the Fisher effect would drive

longer-term rates to ranges different from those envisioned by policymakers.

5. The Miller and Volcker Federal Reserve, 19781987

Under the tenure of Federal Reserve Chairman Miller (1978 to 1979), it continued to be the case

——————————————————————————————————————————

From Burns’ testimony of July 26, 1977, in Committee on Banking, Finance and Urban Affairs, House of

Representatives (1977, p. 59). Also in Burns (1977b, p. 718).

Again, this appeared in Committee on Banking, Finance and Urban Affairs, House of Representatives (1977, p.

59) and was also printed in Burns (1977b, p. 718).

that the Federal Reserve outlined its medium-term plans for monetary growth, but not for interest

rates. Legislation passed in 1977 and 1978 saw further formalization of the requirement that the

Federal Reserve set monetary-growth targets. Taking these mandates into account, Federal

Reserve Board Governor Charles Partee noted in early 1979 that—again, in conformity with

what the law required—the FOMC had announced monetary growth targets for the year ahead

only. He added, however, that the law also clearly carried the implication that in the years from

1980 to 1983 the FOMC would further adjust its target rate downward to bring monetary growth

toward the value that was believed consistent with long-run price stability.

On an earlier occasion, Partee made clear that he did not believe that the projections that the

Federal Reserve provided should be broadened to include interest rates. On May 9, 1978, he had

testified: “But, as far as interest rates are concerned, I don’t like to be in the position of having

the central bank predict interest rates. I think that is a poor policy procedure, because financial

market participants may act on the basis of those predictions—and may themselves fulfill the

prophecy. And I might say that having coped [in] this area for many years, we are no better at

predicting interest rates than anybody else, so we shouldn’t be giv[ing] that kind of emphasis.”

As Partee’s comments indicated, the Miller tenure was characterized by continuing reluctance on

the part of Federal Reserve policymakers to articulate their interest-rate forecasts. And the

reasons cited for this reluctance were the same as those given before: that the forecasts would be

unreliable and that preparing and disclosing them would introduce an undesirable new factor in

the pricing of assets in financial markets.

Miller’s period as Federal Reserve chair was, nevertheless, one in which considerable

momentum developed for the FOMC to provide economic forecasts. In the face of this pressure,

Miller voiced his judgment that the notion of a single set of FOMC-produced forecasts—a joint

Committee product—was impractical: “the Federal Open Market Committee is a collegial body

[but] believe me, to get twelve people to ever adopt or agree on the precise numbers for a

forecast of the economy is unlikely,” he testified on February 21, 1979.

——————————————————————————————————————————

Testimony by J. Charles Partee on March 13, 1979, in Committee on Banking, Finance and Urban Affairs, House

of Representatives (1979a, pp. 67). Similarly, Chairman Miller himself had testified on April 25, 1978, that “the

FOMC… remains firmly committed to a gradual reduction in monetary growth over time to rates more nearly

consistent with reasonable price stability” (Miller, 1978, p. 376).

From Partee’s testimony in Committee on Banking, Housing, and Urban Affairs, U.S. Senate (1978, pp.

217218).

In Committee on Banking, Finance and Urban Affairs, House of Representatives (1979b, p. 104).

The following July, Paul Volcker, then vice chair of the FOMC, was nominated for the chair

position, Miller having announced he was stepping down. In his confirmation hearing, Volcker

articulated aspects of his position on interest-rate projections that he would repeat throughout his

eight-year tenure as chair. These were, first, an aversion to forecasting rates and, in particular, to

the proffering of numerical details concerning the short- to medium-run prospects for nominal

short-term interest rates. Second, a willingness in general terms to acknowledge that disinflation

required a prolonged period in which nominal interest rates were high. Third, a tendency to

invoke the Fisher relationship, when pressed about the trajectory of interest rates. These facets

of Volcker’s position echoed points his predecessors had articulated. But they became especially

important in Volcker’s period because he presided over a large decline in inflation, with the

disinflation process involving two recessions during the early 1980s.

When asked at the confirmation hearing if he felt “that interest rates should be higher?,” Volcker

declined to be drawn on the matter. “I don’t think I want to begin my career as chairman by

projecting just where interest rates might be or where they should be. I guess that’s something

we continue to look at as time passes [but] it depends on too many crosscurrents in the economy

for it to be sensible for me to try to make a prediction at this point.”

Elsewhere in the testimony, Volcker relied on the Fisher relationship to point to the lower

interest rates that would eventually stem from tight monetary policy: without tight policy against

inflation, he said, one could not sustain “interest rates as low as they used to be.”

This meant,

he explained, that over longer periods it was not axiomatic that “restrictive policies mean high

interest rates” and also that it was possible that monetary restraint would reduce nominal longer-

term rates promptly.

Volcker further implied, however, that general interest-rate declines would

likely not occur until inflation declined.

In written remarks submitted for inclusion in the record of these hearings, Volcker indicated that

he was comfortable with the FOMC’s laying out of targets for the year’s monetary growth as a

means of expressing “communication and policy intentions,” and that although “further

——————————————————————————————————————————

From Volcker’s testimony of July 30, 1979, in Committee on Banking, Housing, and Urban Affairs, U.S. Senate

(1979, p. 20).

From Volcker’s testimony of July 30, 1979, in Committee on Banking, Housing, and Urban Affairs, U.S. Senate

(1979, p. 5).

From Volcker’s testimony of July 30, 1979, in Committee on Banking, Housing, and Urban Affairs, U.S. Senate

(1979, p. 19).

See Volcker’s testimony of July 30, 1979, in Committee on Banking, Housing, and Urban Affairs, U.S. Senate

(1979, p. 38).

improvement” in policy communications was likely, “I have no specific suggestions for

improving the flow of information on monetary policy at this time.”

By this stage, however, a notable innovation in communication about the economic outlook had

occurred. This had been in the pages of the Federal Reserve Board’s semiannual Monetary

Policy Report, released on July 17, 1979, shortly before Chairman Miller announced his

departure. In keeping with the requirement of the Full Employment and Balanced Growth Act of

1978 that the Federal Reserve report policymaker forecasts, this report included a table of

projection ranges for the fourth-quarter values of 1979 and 1980 of the unemployment rate, four-

quarter inflation, and the four-quarter growth rates of aggregate nominal and real income.

Offered “in order to improve understanding of the monetary objectives,” the table was identified

as a distillation of policymaker forecasts—specifically “an economic projection representing the

consensus of the Board members at this time” (Federal Reserve Board, 1979, p. 601). Because

this table was derived from individuals’ forecast submissions, it did not represent a single

collective forecast: As already noted, Volcker’s predecessor had expressed doubt about the

feasibility of agreement on such a single forecast. Analogous tables throughout Volcker’s tenure

appeared in subsequent Monetary Policy Reports, with Reserve Bank presidents’ projections

soon being included along with governors’ projections in the generation of the forecast ranges

(see Romer, 2010).

Despite their regularity, these forecasts usually did not figure prominently in policy

communications under Volcker, in part because he did not particularly emphasize them in his

public pronouncements.

Most importantly for our purposes, these public FOMC forecasts did

not include explicit interest-rate forecasts of any kind.

——————————————————————————————————————————

In Committee on Banking, Housing, and Urban Affairs, U.S. Senate (1979, p. 57).

Romer (2010, p. 951) gave the “published forecasts… [as] reflect[ing] the views of the members of the Federal

Open Market Committee” (by which, as he noted, he included presidents not currently voting in FOMC meetings).

This was not a correct description of the forecasts in the July 1979 and February 1980 Monetary Policy Reports (see

Federal Reserve Board, 1979, p. 601; 1980a, p. 179), which were based on forecasts of the Board governors only,

with no presidents included. However, it accurately described the Monetary Policy Report forecasts starting in the

report for July 1980 (see Federal Reserve Board, 1980b, p. 532). The change between the practices in the February

and July 1980 Monetary Policy Reports was the outcome of an exchange Volcker had when presenting the former

report in Congressional testimony. Volcker agreed with a questioner that it was more informative to present forecast

information that arose from input provided by all the FOMC policymakers, as opposed to drawing on the Board

members alone. Volcker indicated that the latter practice had originally been judged as closer to what was legally

required of the Federal Reserve but that FOMC forecast information would be given in the Monetary Policy Report

from now on. (See the exchange of February 25, 1980, in Committee on Banking, Housing, and Urban Affairs,

1980, p. 44.) The Volcker period therefore saw the forecasts of the whole of the FOMC (broadly defined to include

all bank presidents) being brought into the construction of the tabulated forecast ranges.

Volcker did, however, draw attention to the forecasts on occasion. For example, he highlighted them in his

opening testimony of April 12, 1983, in connection with the Federal Reserve’s semiannual report on monetary

At a meeting with members of the media on August 23, 1979, Volcker did make the minor

concession of indicating that interest rates were unlikely to fall in the near future: “I know of no

way to get these interest rates down in the present environment.”

The Associated Press report

on Volcker’s remarks (Nokes, 1979) noted his emphasis on the Fisher effect: “The view that

interest rates rise like the tide with inflation was also held by Volcker’s two immediate

predecessors as board chairman, G. William Miller and Arthur Burns.”

A turning point in Volcker’s period as chair occurred in October 1979 when the FOMC switched

from targeting monetary growth using the federal funds rate as an instrument to making

nonborrowed reserves the key instrument in monetary targeting. Numerous retrospectives have

interpreted this arrangement, which continued into 1982, as a covert means by which the FOMC

continued to manage the federal funds rate while moving it to high levels.

Volcker, however,

would consistently reject interpretations of this kind (see, for example, the discussion in Taylor,

1995, p. 780).

Irrespective of one’s view about the materiality of the change in operating

procedures that occurred in October 1979, it is not in doubt that the FOMC shifted at that point

to a posture in which it was willing to countenance greater short-run variation in the federal

funds rate than previously, in the hope of securing desired outcomes for monetary growth. This

——————————————————————————————————————————

policy (see Volcker, 1983, p. 339). Among outside observers who pointed to the forecasts, James Tobin was

especially notable. In 1985, he argued that “the regular summary of the GNP, price and unemployment ‘projections’

of the seven Federal Reserve [Board] governors and twelve Federal Reserve Bank presidents assume major

importance” because they revealed forecasts of the FOMC’s ultimate goal variables (Tobin, 1985, p. 25; p. 183 of

1987 reprint). The Tobin article was reprinted in a book of readings, edited by Ben Bernanke, that appeared in

1987. Twenty years later, Bernanke would bring the policymaker forecasts into far greater prominence by

overseeing a comprehensive overhaul—when the presentation of the forecasts, in more frequent and extensive form,

became the basis for the Summary of Economic Projections (SEP) of FOMC participants. Starting in 2012, the SEP

included statistics on individual policymakers’ policy-rate projections.

Quoted in Nokes (1979). Of course, as the option was available to reduce short-term interest rates by easing

monetary policy on the margin, Volcker’s statement was not wholly valid. He was likely referring to an interest-rate

reduction that could be sustained and that could be counted on to be registered across the maturity spectrum.

As discussed above, this position had been taken by Chairman Martin, too.

See, for example, Mishkin (1987, p. 46). Many studies, including the celebrated work of Judd and Rudebusch

(1998) and Clarida, Galí, and Gertler (2000), have underlined the importance of the October 1979 policy change by

showing how the Federal Reserve’s reaction function, as represented by an estimated federal funds rate rule, shifted

between the pre- and post-1979 periods. Findings of this kind are not necessarily inconsistent with the notion that

the FOMC withdrew from targeting the federal funds rate during the period from 1979 to 1982. One could take the

FOMC’s announced shift to a nonborrowed-reserves regime at face value, while regarding equations for the federal

funds rate estimated over 1979 to 1982 as a valid means of representing monetary policy developments, because

those equations quantify what the nonborrowed-reserves regime implied for the relationship between movements in

the funds rate and in the state of the economy. See also the discussion in Clarida, Galí, and Gertler (2000, p. 163).

At an early stage, Volcker placed on the record his rejection of these interpretations of the 19791982 regime.

For example, in the course of Congressional testimony on April 12, 1983, he remarked: “I’m perfectly willing to say

that… we recognize[d] that it might come about that interest rates [would] go higher and be maintained at a higher

level for a considerable amount of time. But I think it is just wrong to suggest that we sat there [at FOMC meetings]

and said: ‘We think, right now, a 16 or 18 percent interest rate is what is called for, in terms of the inflationary

situation.’” (In Committee on Banking, Finance and Urban Affairs, House of Representatives, 1983, p. 45.)

new environment lent itself to the repetition by Volcker, when talking about interest rates, of the

themes that he and his predecessors had already emphasized, even when they explicitly set

interest rates: that it was hazardous to forecast interest rates because the interest-rate values

consistent with policymakers’ stabilization goals were hard to know ahead of time; and that

inflation outcomes dominated the longer-term behavior of nominal interest rates.

Against this backdrop, the new regime was not characterized by forward guidance on interest

rates. Volcker did indicate in his public statements that he and his colleagues had opted for a

regime change that was designed to produce conditions of price stability.

But Volcker largely

abstained from commenting on what this new regime likely implied for short-term interest rates

over the period ahead, other than over the far horizon associated with the dominance of the

Fisher effect on those rates.

Along these lines, in testimony given in the second full week of the new regime, Volcker

remarked: “I am very reluctant to give you—and I’m just not going to give you—a precise

estimate of interest rates in the period ahead, or how long the adjustment [of] levels of interest

rates might last.” He elaborated that “interest rate forecasts… are perhaps even more uncertain

than general economic forecasts—and I don’t think it’s wise for me to imply a degree of

certainty that doesn’t exist in this world by making such estimates.” Once again, he fell back on

the Fisher relationship to permit a broad-brush description of the interest-rate outlook: “by acting

forcibly now, we bring the day of lower interest rates… sooner rather than later.”

When,

however, in a round of questioning later in the hearing, he was asked how soon interest rates

might start coming down, Volcker replied: “I refused to give a quantitative estimate to Senator

Javits, and I can’t give you any special privileges.”

In testimony the following March, Volcker observed: “In my present position, Senator Bellmon,

I carefully refrain from making predictions about interest rates. I have found that a very wise

decision so far, because I probably would have made some wrong ones if I had been inveigled

——————————————————————————————————————————

See, for example, the Volcker observations quoted in Lindsey, Orphanides, and Rasche (2005, p. 207).

He would later contend that the FOMC had, in effect, implied interest rates would be high for a prolonged period.

“I think we said explicitly, when we made the [October 1979] announcement, that we would expect a lot more

fluctuations in interest rates, and [we] implied in that statement that the possibility that they would be higher for a

while,” Volcker testified on April 12, 1983, while adding, “I didn’t expect interest rates to be as high for as long as

they were” (in Committee on Banking, Finance and Urban Affairs, House of Representatives, 1983, p. 41).

From Volcker’s testimony of October 17, 1979, in Joint Economic Committee (1980, p. 21).

From Volcker’s testimony of October 17, 1979, in Joint Economic Committee (1980, p. 26). In a television

appearance (on ABC’s Issues and Answers: see Associated Press, 1979) eleven days later, Volcker did venture to

say: “I have no hesitation in saying that the kinds of policies we are following will bring interest rates down quicker

and lower than if we took any other approach.”

into making any public or private predictions. I am not about to suggest just what the level of

interest rates might be.” Along with inflation, Volcker pointed to federal government borrowing

as another factor that was holding up nominal interest rates—a consideration that led him to

conclude that tight monetary policy becomes “more compatible with declines in interest rates as

you make progress on the budget.”

He further noted that trying to reduce interest rates without

evidence of progress on the disinflation front would “put the cart before the horse” and would

produce both higher inflation and higher interest rates in the future.

In an appearance on the U.S. public television news program The MacNeil/Lehrer Report on

April 21, 1980, Volcker stated that he was willing to assume (accurately) “that the economy is

softening, that we are in a recession.” In those circumstances, policies that delivered restrained

growth in monetary aggregates would be consistent with declining interest rates, as “you would

normally expect the demand for credit to subside in a recession.” Volcker noted that interest

rates were already showing some “tentative signs, anyway, of a subsiding.”

However, he then

reproached himself for being about to add that interest rates were beginning to go down. The

reason for his reluctance to make such a prediction, Volcker remarked, was that “I like to leave

——————————————————————————————————————————

Testimony of March 24, 1980, in Committee on the Budget, U.S. Senate (1980, p. 263).

In Committee on the Budget, U.S. Senate (1980, p. 266). This statement puts in perspective the construction on

historical U.S. monetary policy implicitly placed by Uribe (2020). That study sees a central bank as capable of

reducing nominal interest rates and inflation in tandem and in a single step by shifting to a new low-inflation

monetary policy. Consideration of this “neo-Fisherian” position concerning the transmission mechanism is beyond

the scope of the present paper, but what does bear on the discussion here is that Uribe (2020) also implicitly

hypothesizes about the views held by policymakers during the Volcker disinflation, by suggesting that Volcker may

well have himself believed that interest rates and inflation were capable of being reduced simultaneously. In

contrast, the record clearly implies, instead, that Volcker saw the central bank’s means of permanently reducing

short-term interest rates, when starting from a situation of high inflation, as comprising a (more conventional) two-

step process: rates would need to rise initially as part of the process of a monetary policy tightening, and they later

could permanently fall to a lower rate when the disinflation took hold. More Volcker statements to this effect are

given below.

See PBS (1980). In the 1980s, research on monetary policy in the March-July 1980 period widely agreed it to

have been restrictive, indeed very restrictive, as the combination of the FOMC’s new policy regime and the credit

controls imposed by the Federal Reserve Board (at President Jimmy Carter’s request) led to a severe monetary

squeeze and output contraction—the latter forming the 1980 recession (see, for example, Blanchard and Watson,

1986, p. 135). These accounts acknowledged that short-term interest rates fell steeply in this period but emphasized

the extent to which this was a reflection of weak demand for loans rather than connoting monetary policy ease (see

especially Bernanke, 1988, p. 10). In contrast, some later accounts have taken the sharp decline in the federal funds

rate over this period as implying that the FOMC went through a phase during 1980 in which it greatly eased policy,

abandoning the policy of disinflation announced in 1979 (see Goodfriend and King, 2005, pp. 986, 9991000;

Nakamura and Steinsson, 2018, p. 72). It may be that these retrospectives are correct in contending that (whether

the FOMC intended this or not) actual monetary conditions became loose for a time in 1980 (although some of the

evidence cited for the looseness of monetary policy in this period—such as the fact that the inflation rate was high

during 1980—rests on an assumed instantaneous reaction of inflation to FOMC policy settings). But the position

that there was a deliberate abandonment of the disinflation program on the part of Volcker’s FOMC seems

inconsistent with a good deal of the contemporaneous record—most notably that contributed by Volcker himself.

See the next footnote.

forecasts of interest rates to the people paid for forecasting interest rates.” He reaffirmed,

however, that an interest-rate decline “would be a normal thing to happen in a recessionary

period.”

At a hearing in September 1980, Volcker was asked: “What can we expect to happen to interest

rates in the near future?” He replied: “I wish I knew. I don’t generally put myself in a position

of forecasting interest rates, and I won’t do so this morning.”

This mixture of shunning

disclosure of his personal interest-rate outlook and expressing little confidence in it was repeated

during a public appearance Volcker made in Chicago the following month. Volcker told his

audience: “I cannot promise you that I know which way interest rates will go or promise you

stability.” In this appearance, Volcker also gave a lighthearted version of his mantra about the

undesirability and difficulty of predicting interest rates: “I religiously refrain from giving any

interest rate forecasts. I do it partly as a matter of self-defense: I don’t want [by giving poor

predictions] to shatter your opinion of my competence.” He also returned to the Fisher effect,

this time applying it to the whole maturity structure of interest rates: “I don’t see any way of

moving the interest rate curve down in any sustained way, unless there is some sustained

progress on the inflation front.”

With predictions of interest rates anathema to him, Volcker provided clarity during this period

about future monetary policy by confirming that the FOMC intended to continue disinflation

plans by lowering its monetary-growth targets in the years ahead. In September 1980, for

example, he noted that, in the previous July, the FOMC had reaffirmed its monetary-growth

target for 1980 and had tentatively set a lower target rate for 1981, in line with the need to reduce

——————————————————————————————————————————

Again, see PBS (1980). Early in the new regime, Volcker had noted (October 17, 1979, testimony, in Joint

Economic Committee, 1980, p. 22) that interest rates would behave cyclically in that regime, so if they declined

during a recession, “that should not be taken as a shift in our basic policy.” And as just indicated in the text, in

March 1980 he foreshadowed the decline in short-term interest rates in spring-summer 1980 in just such a light.

Taking stock the following September, Volcker likewise attributed the “enormously rapid decline” in short-term

rates during the year to the steep fall in aggregate output (September 10, 1980, testimony, in Committee on the

Budget, House of Representatives, 1980, p. 161). (These interpretations were also made by policymakers in their

internal deliberations. For example, Federal Reserve Board Governor Henry Wallich noted in a mid-1982 FOMC

meeting that it was part of the logic of the new procedures that interest rates would decline automatically in

recessions, and he observed that they had indeed done so during the 1980 recession. See Federal Open Market

Committee, 1982a, p. 7.)

Testimony of September 10, 1980, in Committee on the Budget, House of Representatives (1980, p. 160).

Quoted in Barnhart (1980). The last remark was one of many occasions in the 1970s and 1980s when Volcker

publicly stressed the influence of inflation expectations on longer-term interest rates. Contrary to the implication of

Goodfriend and King (2005, p. 981), his belief in this influence was not a new piece of information disclosed for the

first time publicly by the release, in 2004, of the 1979 and 1980 FOMC meeting transcripts.

monetary growth over time.

In keeping with this observation, Volcker testified early the

following year that protracted restraint was a “posture [that] should be reflected in further

deceleration in the monetary aggregates in the years ahead. That seems to us an essential

ingredient in any effective policy to restore price stability.”

By this stage (late February 1981), the declines in interest rates seen around the middle of the

previous year had essentially been fully reversed. Consequently, notwithstanding Volcker’s

efforts to center monetary policy discussions on monetary growth, public discourse was highly

focused on interest rates and the Federal Reserve’s role in generating them. Though the

nonborrowed-reserves procedure meant that Volcker did not present the federal funds rate as

chosen by the FOMC, he did not deny that the FOMC’s actions inevitably had a bearing on that

rate.

In addition, as the discount rate remained an administered rate and was not fixed by

formula to market rates, its movement—a steep increase, from 10 percent in July 1980 to 13

percent in December 1980—had stemmed directly from Federal Reserve Board decisions.

Against this backdrop, Volcker voiced hope that short-term rates would fall, but he relied on the

Fisher relationship as the basis for this expectation. “The impact of the discount rate on the

money market in the short run, which may be present in many circumstances,” Volcker testified

in February 1981,” is quite a different thing from the impact of that discount rate change over a

period of time, which may be precisely the reverse of the short-run influence…”

100

In other

testimony given in the same month, he declared that lowering the inflation rate and inflation

expectations amounted to the “one way of getting interest rates down.”

101

Volcker elaborated that

“in a sense, the whole purpose and thrust of our policies, ironic as it may sound, is to bring

——————————————————————————————————————————

Testimony of September 10, 1980, in Committee on the Budget, House of Representatives (1980), p. 156).

Likewise, during an answer in a hearing on February 5, 1981, Volcker stated that “the general outline of our

intention… is to work toward lower rates of monetary growth” (in Joint Economic Committee, 1981, p. 8).

Testimony of February 26, 1981, in Committee on Banking, Finance and Urban Affairs, House of Representatives

(1981, p. 12). For a similar Volcker remark, given in testimony in another hearing during the same period, see

Broaddus and Goodfriend (1984, p. 3).

For example, in a television interview on August 30, 1981, Volcker stated (ABC, 1981, p. 2): “We are restraining

the supply of money and credit [when] there’s a lot of demand for money and credit. At the moment, that means

high interest rates.” Another example was Volcker’s testimony of February 10, 1982, in which he noted that a

“short-run influence” on interest rates of the restrictive monetary policy currently in force was that it was “tending to

keep short-term rates [up] in particular” (in Committee on Banking, Finance and Urban Affairs, House of

Representatives, 1982, p. 67).

The Board had raised the discount rate in three steps over this period. See

https://fred.stlouisfed.org/series/DISCOUNT.

100

Testimony of February 26, 1981, in Committee on Banking, Finance and Urban Affairs, House of

Representatives (1981a, p. 139).

101

February 5, 1981, testimony, in Joint Economic Committee (1981, p. 12).

interest rates down... Interest rates will come down and stay down as the inflation rates get

down... I know of no other answer...”

102

Beyond these invocations of the Fisher effect, Volcker in these February 1981 appearances

would not be drawn on the outlook for interest rates: “One thing I refrain from… is from

forecasting interest rates.”

103

That was a posture he was continuing to take a year later, in late

February 1982. By this point, inflation had fallen considerably, but nominal interest rates were

still in high double digits. On February 24, 1982, to a senator’s question, “Would you be willing

to predict what the prime rate of interest will be at the end of 1982?,” Volcker replied, “No,”

affirming, “I religiously refrain from such projections.” Pressed by the questioner whether the

prime rate “will not be much below what it is now,” Volcker insisted: “You are not going to lure

me into a precise prediction of that sort.”

104

He did volunteer that he expected downward

pressure on interest rates to be generated both by declining inflation and by a move downward in

real rates from their “extraordinarily high” current levels. Consequently, Volcker expected

nominal rates to “decline, and to decline even with business recovery. But just how much time

that will take… I don’t want to try to be precise about.”

105

As of February 1982, therefore, Volcker seemed to view interest rates as unduly high but

regarded the onus as being on the private sector’s expectations, rather than overt Federal Reserve

actions or communications, to bring short-term interest rates down. In the hearing just quoted,

he implied that if the FOMC took the initiative, it could be perceived as acting prematurely and

might provoke an adverse result, such as a return to rising interest rates within a few months.

106

Over the course of 1982, however, Volcker and his FOMC colleagues would become more

comfortable with pressing market interest rates down. Indeed, they would eventually choose to

carry this out through resumed Federal Reserve management of short-term rates. An early

——————————————————————————————————————————

102

February 5, 1981, testimony, in Joint Economic Committee (1981, p. 21). Similarly, on television a few days

earlier, Volcker had stated that “the basic outlook over a period of time” for interest rates was “really dependent

upon what we do about this inflation problem” (interview in ABC’s Issues and Answers, February 1, 1981, quoted in

New York Times News Service, 1981).

103

From Volcker’s testimony of February 5, 1981, in Joint Economic Committee (1981, p. 10). He made a similar

remark in a hearing held on June 25, 1981 (Committee on Banking, Finance and Urban Affairs, House of

Representatives, 1981b, p. 269).

104

A couple of weeks earlier, Volcker had reiterated his belief in the unreliability of such predictions, including his

own: “I don’t have great faith in my ability to project precise levels of interest rates in the short run or in the long

run… There’s bound to be a lot of ‘iffiness’ in any interest rate projection. But I think the kinds of measures that

need to be taken to maximize the chances [of] low interest rates are quite clear.” (Testimony of February 10, 1982,

in Committee on Banking, Finance and Urban Affairs, House of Representatives, 1982, p. 52.)

105

In Committee on Finance, U.S. Senate (1982, p. 101).

106

In Committee on Finance, U.S. Senate (1982, p. 116).

development in setting the stage for this shift occurred in March 1982, when Volcker partially

broke his self-denying ordinance concerning interest-rate predictions. A speech Volcker gave on

March 18 to a business audience led to a news report that opened: “The Federal Reserve

Chairman Mr. Paul Volcker yesterday… predicted falling interest rates and a brighter economic

future.” It quoted Volcker telling the audience: “If I were not the chairman of the Federal

Reserve Board, I will see a decade of declining interest rates. Certainly rates will start from a

high enough level.”

107

On the same occasion, Volcker stated that he “would love to see interest

rates come down, but I want to see them stay down—I don’t want a roller coaster.”

108

This note

of caution was consistent with Volcker’s continued emphasis on the Fisher effect, rather than a

concerted policy easing, as the means by which he wanted to see rates fall: the FOMC did “not

mean to abandon that effort [that is, of reducing monetary growth], and we think it is central to

reduced interest rates over time.”

109

Provided that the fight against inflation was successful,

“interest rates have nowhere to go but down,” Volcker told the audience.

110

Internal deliberations in the FOMC over the following months clearly showed that they remained

reluctant to take moves designed to lower nominal interest rates for fear that this would be a

precipitate easing.

111

As is well known, however, after the middle of the year the FOMC decided

to take steps to lower interest rates—the federal funds fell from an average of over 14 percent in

June to an average just below 9 percent in December—and to deemphasize M1, for which the

FOMC permitted a substantial overshoot of the 1982 target. In effect, the FOMC in the mid- to

late-1982 period returned to a permanent arrangement of managing the federal funds rate,

although Volcker’s FOMC was not forthright about this fact (see Thornton, 2006).

In this new environment, Volcker was not only reticent with regard to the FOMC’s use of the

current short-term interest rate as the focus of its period-to-period decisions, but he also

remained reluctant to give FOMC projections of those or other interest rates. In August 1983,

——————————————————————————————————————————

107

The article (Brummer, 1982) explained the start of this quotation by noting: “Federal Reserve chairmen never

forecast interest rates.”

108

Quoted in Buckhout (1982, p. A1).

109

Quoted in Buckhout (1982, p. A18).

110

Quoted in Washington Bureau (1982, p. 2).

111

See, for example, the discussion in the FOMC meeting of March 2930, 1982 (Federal Open Market Committee,

1982a). During this discussion, Volcker expressed reservations, similar to those he had articulated publicly, about

the option of the Federal Reserve taking vigorous actions to lower interest rates (pp. 5051). This posture was still

evident in Volcker’s Congressional testimony of June 15, 1982, in which he continued to indicate that he considered

market interest rates to be too high, while implying that the FOMC was not prepared to take the initiative by

stepping in to bring short-term interest rates down (see Joint Economic Committee, 1982, pp. 446, 454). This

testimony also had Volcker repeat his maxim (p. 456): “I refrain from making precise forecasts of interest rates, and

I think I’d better stick to that approach.”

Volcker testified in hearings that were devoted to the question of how the Federal Reserve

should communicate its plans and goals. In a written submission to this inquiry, former longtime

FOMC policymaker Philip Coldwell had suggested that the published Monetary Policy Report

table of FOMC participants’ forecast ranges should be expanded to include additional

information, including their projection ranges for the current and following year’s average levels

of the federal funds rate.

112

In his testimony, Volcker rejected this suggestion, instead

maintaining: “In the case of interest rates, there would be the obvious prospect of

misinterpretation and misunderstanding, were the Federal Reserve [to be] required to announce

regularly [its] forecasts…. The forecast… would itself become an important market factor

[and]… the result would often be to mislead market participants and provide false signals.”

113

In elaborating on this point, Volcker reiterated positions that he and other Board governors had

propounded in previous years when rebutting previous calls for policymaker interest-rate

forecasts. As an interest-rate forecast provided by FOMC members was likely to become a

“focus of public attention,” Volcker suggested, the Federal Reserve would feel obliged to take

policy actions that validated the ex post accuracy of the forecast even if it became evident that

the values of the interest rate given in the forecast were proving not to be those most consistent

with the achievement of policymakers’ macroeconomic goals. The associated FOMC “hesitancy

in allowing interest rates to fluctuate in accordance with emerging—and possibly

unanticipated—market pressures,” Volcker contended, would make the announced interest-rate

projections a “destabilizing force for the economy as a whole.”

114

Volcker therefore exhibited continuing negativity with regard to foreshadowing the medium-

term consequences for interest rates of FOMC decisions. In line with this perspective, Volcker

during the remainder of his tenure as chair (through 1987) relied on citing the longer-term, and

familiar, influences on interest rates, with his discussions of interest-rate prospects stressing the

Fisher effect and federal borrowing.

115

In a hearing held on February 7, 1984, for example,

Volcker indicated that budget deficits were elevating the values of the real interest rate consistent

with economic stabilization and that high nominal longer-term interest rates in part reflected

——————————————————————————————————————————

112

See the remarks in the letter (dated July 7, 1983) from P.E. Coldwell to Congressman Walter E. Fauntroy, in

Committee on Banking, Finance and Urban Affairs, House of Representatives (1983, p. 296).

113

From Volcker’s testimony of August 3, 1983, in Committee on Banking, Finance and Urban Affairs, House of

Representatives (1983, p. 181).

114

From Volcker’s testimony of August 3, 1983, in Committee on Banking, Finance and Urban Affairs, House of

Representatives (1983, p. 185).

115

The latter factor, though it had already been frequently emphasized by Volcker and his predecessors in the years

up to 1981, had become of elevated importance in public discussion in the wake of the large federal deficits that

characterized the budgets of the Reagan administration.

market concerns about the possibility of an eventual monetization of Treasury debt issuance.

Other than his articulation of the FOMC’s monetary-growth targets, what forward guidance

Volcker provided on this occasion consisted mainly of his ruling out of particular scenarios

involving an untoward monetary easing. In particular, he affirmed the Federal Reserve’s resolve

not to accommodate the deficits or to generate interest-rate reductions that were considered

inconsistent with a monetary policy strategy geared toward price stability.

116

This emphasis on

what the FOMC would not do in the future contrasts with modern forward guidance, in which

the FOMC describes the modal course of monetary policy settings in terms of the interest rate.

Likewise, in March 1985, when asked about the course of interest rates, Volcker stressed federal

borrowing and inflationary expectations. Speaking when the federal funds rate was about 8.5

percent, Volcker remarked: “You can get an interest rate of 6 percent, or less, I would hope by

1990, or whatever year you projected, depending upon… the inflation rate… [and] what the

balance is in the economy. If you want to get an interest rate of that kind, there is no greater

contribution you [that is, members of Congress] can make than to take forceful budgetary action

today.”

117

6. The Greenspan Federal Reserve and the transition to forward guidance

The era of Alan Greenspan as Federal Reserve chair (1987 to 2006) would eventually see the

introduction of forward guidance into FOMC policymaking. Greenspan started out, however,

voicing similar reservations about policymaker provision of interest-rate projections to those that

had been expressed by Federal Reserve Board members, including chairs, in past years.

In February 1988, Greenspan remarked in testimony that “the difficulty that we would have in

forecasting interest rates” lay in the fact that “because the Federal Reserve by its nature is

involved [in] and has considerable influence on interest rates, it is very difficult for us to make

forecasts without creating market instabilities.” When a questioner then suggested that “the

beauty of that [a practice of providing interest-rate projections] is you could make your

assumptions come true,” Greenspan disagreed: “No, I’m afraid it wouldn’t [be like that,] because

——————————————————————————————————————————

116

See Committee on Banking, Finance and Urban Affairs House of Representatives (1984, pp. 910). This hearing

also saw Volcker give voice once again to his now very familiar posture regarding interest-rate projections: “I

haven’t any particular expectations... I try to avoid making those projections at all.” When this remark prompted his

questioner to suggest that it would be “instructive” for the Federal Reserve chair to provide their perspective on the

interest-rate outlook, Volcker replied: “It might be instructive, but I religiously refrain from trying to forecast

interest rates.” (Committee on Banking, Finance and Urban Affairs, House of Representatives, 1984, p. 53.)

117

Testimony of March 6, 1985, in Committee on the Budget, House of Representatives (1985, p. 378).

the irony of this exercise is that, if we were to forecast interest rates, the chances are [that] the

markets would create an environment which would probably make our forecast wrong.”

118

Evidently, Greenspan believed that announced policymaker forecasts of future short-term rates

would immediately affect long-term rates. But, like his predecessors, he seemed to believe that

this reaction might well generate a degree of monetary accommodation or tightness that would

ultimately mean that the values of the short-term rate given in the policymaker projection

corresponded to an inappropriate stance for monetary policy. In the early Greenspan years,

therefore what would come to be seen as benefits of guidance—that short-term interest-rate

guidance could both be validated by later rate decisions (the forecast could prove correct) and

steer current longer-term rates in a stabilizing manner (the guidance could reinforce monetary

policy strategy)—were viewed as involving a balancing act that was in practice out of

policymakers’ reach.

Greenspan reiterated this attitude at another hearing held about a week later. Greenspan affirmed

that “they don’t let me forecast interest rates in this job... In fact, there will probably be a hook

which will come down from the ceiling and drag me away if I tried.” He proceeded to give the

“more fundamental reason” for not doing so: “Because we on the Federal Open Market

Committee can affect the movements of interest rates, if I or any of my colleagues publicly

forecast rates, the immediate effect would be a market adjustment reflecting beliefs that, in

effect, we were going to take actions to create [that is, validate] that particular forecast. The

trouble, unfortunately, is that the adjustment occurs far faster than any of us would like to

imagine, and you create instabilities as a consequence of that. In other words, the mere fact of

the markets adjusting to a prospective change in monetary policy… can actually undercut the

purposes of that policy by inducing much more rapid change—more instability.” He concluded

that he did not “think it would serve the purposes of the country” to have FOMC-provided

interest-rate forecasts.

119

This wary attitude was echoed in Greenspan’s statements over the following decade. For example, in

appearances made during March 1989, he observed, “I hopefully have been very cautious not to

forecast interest rates,” while maintaining that “we are not in the business of forecasting interest

——————————————————————————————————————————

118

From the exchanges in the hearing of February 24, 1988, in Committee on Banking, Housing, and Urban Affairs,

U.S. Senate (1988, p. 68).

119

From Greenspan’s testimony of March 3, 1988, in Committee on the Budget, House of Representatives (1988, p.

26). The rendering of the quotation given here has corrected a “perspective” in the original document to

“prospective.”

rates and really cannot.”

120

Consistent with this attitude, the 1990s would see the FOMC, in

1994, move to a practice of same-day announcements of its changes in the federal funds rate, but

for most of the decade the FOMC’s communications about future monetary policy focused on its

macroeconomic objectives rather than its likely settings of the funds rate.

121

Against this

backdrop, in October 1997 Greenspan replied to a Congressional question concerning whether

“the Fed would look in the future to lowering interest rates” or whether there remained “a need

to raise interest rates,” by observing, “Senator, I don’t know of any way I can answer that

question without getting myself in[to] trouble.”

122

Nevertheless, the course of Greenspan’s first decade as Federal Reserve chair saw a distinct shift

on the part of Federal Reserve officials. They became more receptive to the idea of consciously

influencing longer-term interest rates by providing signals concerning future short-term interest

rate policy.

An early public sign of this shift was given in a talk that Donald Kohn, head of the Federal

Reserve Board’s Division of Monetary Affairs, gave in October 1990 titled “Making Monetary

Policy: Adjusting Monetary Policy to Achieve Final Objectives.”

123

Kohn outlined what he

referred to as a “view of the transmission process [that] may serve as a useful organizing

paradigm for the discussion of making monetary policy.”

124

In the view outlined, the “instrument

variable manipulated by the central bank… is taken to be the short-term interest rate,” and this

policy rate contrasted with a benchmark longer-term rate, whose behavior “should give some

sense of where markets expect [short-term] interest rates to move.”

125

FOMC decisions

essentially concerned the “path” of short-term rates, Kohn suggested, and monetary policy

decisions amounted to whether rates should stay along their current path or instead, “an

evaluation of the outlook for prices and economic activity relative to long-run [FOMC]

objectives” justified an adjustment to that interest-rate path.

126

When the FOMC did decide to

——————————————————————————————————————————

120

The quotations are from Greenspan’s testimony of March 2, 1989, in Committee on the Budget, House of

Representatives (1989, p. 449), and of March 22, 1989, in Committee on Banking, Finance and Urban Affairs,

House of Representatives (1989, p. 153), respectively.

121

Furthermore, although monetary-growth targets were regularly announced until 2000, in the period after 1992 the

Federal Reserve’s communication of monetary policy became focused even more than previously on the

achievement of the ultimate objectives of monetary policy, including progress toward, and the maintenance of, price

stability. See, for example, Lindsey (2003, pp. 134135, 141) and Bernanke (2013).

122

From Greenspan’s testimony of October 29, 1997, in Joint Economic Committee (1997, p. 17).

123

See Kohn (1990). The speech was for a conference held by the Reserve Bank of Australia, which published a

proceedings volume for the conference. The speech was consequently part of the public record, though it was little

noticed at its time of publication.

124

Kohn (1990, p. 13).

125

Kohn (1990, pp. 12, 18).

126

Kohn (1990, p. 13).

change its target federal funds rate, the changes “ripple along the yield curve[,] affecting

intermediate and long-term rates… The amounts by which these latter rates will change depend

in part on how well the policy move had been anticipated, and whether it is seen as having

implications for further policy actions.”

127

Kohn’s outline cast market reevaluations of the expected policy rate path that flowed from policy

actions, together with the associated instantaneous adjustment of longer-term interest rates, as an

aspect of the transmission mechanism that was routine and that could complement and reinforce

announced policy actions. This contrasts with the concerns so often voiced in the past by

Federal Reserve officials about markets acting on anticipations of coming policy moves. In

effect, Kohn was articulating a position much closer to that associated with the subsequent era of

forward guidance. Compared with that later era’s consensus, the main difference in Kohn’s

outline was that he took it as incumbent on financial markets to infer the likely course of rates

from its assessment of the FOMC reaction function—and not the task of policymakers to provide

explicit indications of future policy actions when they announced their current policy move.

128

In Congressional testimony given in January 1992, Chairman Greenspan indicated that the

FOMC had been consciously trying to affect the longer-term rate through its short-term interest-

rate policy, and he expressed satisfaction with its success in doing so in recent months. He

explained that in recent times “our major concern was to be certain that, as we moved short-term

rates lower, we could move, induce, drive—whatever the appropriate term is—long-term rates to

move with the short term rates.”

129

In particular, Greenspan suggested that this had been an

important consideration in policy moves made since summer 1991.

130

Over that period, he

recounted, “we accelerated our monetary easing, because it became clear that we now had the

capability of really bringing long-term rates down.”

131

——————————————————————————————————————————

127

Kohn (1990, p. 12).

128

On the parallel position on this matter taken by U.K. policymakers during the 1990s and 2000s, see Fischer

(2017). Central banks in some other inflation-targeting countries were, however, more willing to include their

interest-rate forecasts in their public communications from the mid-1990s onward: see Svensson (2015).

129

Testimony of January 29, 1992, in Committee on Banking, Housing, and Urban Affairs (1992, p. 36).

130

These very explicit statements by Greenspan about the FOMC’s efforts to affect longer-term rates provide a

qualification to Eberly, Stock, and Wright’s (2020, p. 24) statement that “the first use of slope policy [that is, of

FOMC efforts to affect the term structure] in the modern era was the appearance of forward guidance in 2003.” It is

true, however, that the 1992 Greenspan statements given here were made before the FOMC provided postmeeting

press statements and so lacked this means of sending signals about future economic and monetary conditions.

131

Testimony of January 29, 1992, in Committee on Banking, Housing, and Urban Affairs (1992, p. 37). Greenspan

was not, in fact, claiming that the FOMC’s ability to affect long-term rates using short-term rate policy was a new

phenomenon. But he argued that, until recently, long-term inflation expectations were not so well anchored that the

FOMC could, when it acted, take for granted that nominal long-term rates would, on net, move materially and do so

in the same direction as short-term rates (p. 84).

By the end of February 1992, however, the 30-year Treasury bond rate had retraced a good deal

of its previous decline, and the Federal Reserve was reportedly frustrated at the inadequacy of

the response of longer-term rates to the FOMC’s recent easing steps.

132

A couple of years later, a

tightening phase featured the opposite problem: a perceived overreaction of longer-term rates to

the FOMC’s increases in the federal funds rate. In his postmortem on the 1994 episode,

Greenspan (1997) suggested that the large bond-rate rises involved markets unduly “ratcheting

up their expectations [of] further rate increases when we actually tightened.” These assessments

of 19921994 developments suggested that policymakers saw market expectations of future

actions as an important part of the channels through which monetary policy operated. But they

also implied that the market assessments of the policy reaction function that underlay these

expectations were flawed and had led to incorrect inferences regarding future policy actions.

It is in this situation that overt forward guidance provided the opportunity to clarify plans

concerning future interest-rate policy. Something of a false start was made on this score when

the FOMC incorporated, starting in May 1999, into its postmeeting statement an indication of the

Committee’s “tilt” or “bias.” This information, which had previously appeared in the FOMC’s

directive but not in its same-day announcements of policy changes, provided guidance about

very near-term monetary policy by characterizing the likely direction of the next move in the

policy rate. The “tilt”—which formally only applied to any likely move of the funds rate before

the next meeting—was poorly received. It was widely judged as liable to be misunderstood by

financial markets (see Lindsey, 2003, pp. ix, 173177), and Cecchetti (2000, pp. 3335)

contended that the tilt announcements were an instance of policy communications that actually

added to overall uncertainty in the economy.

After less than a year, the tilt was dropped, in a set of changes announced in Federal Reserve

(2000). This announcement implied a mix of expanded and reduced rate guidance: FOMC

announcements would now immediately follow every meeting (not just meetings at which the

funds rate was changed), but the item used to replace the tilt was the “balance of risks.” This

——————————————————————————————————————————

132

See Bleakley and Wessel (1992). This news story opened with the words: “Why can’t the Federal Reserve Board

get long-term interest rates down?” (p. A1; p. 37 of 1993 reprint), and the continuation of the article referred in its

headline to the “plans of the Federal Reserve Board” concerning monetary policy’s influence on longer-term rates

(p. A5). These jarring references to the Federal Reserve Board, rather than the FOMC, may reflect the fact that the

FOMC was still two years away from issuing a press release when it changed its federal funds rate target. In

contrast, the Federal Reserve Board’s changes to the discount rate were officially announced, and so these moves

sometimes had a higher profile than FOMC decisions. In addition, in December 1991 the Board’s 100-basis

reduction in the discount rate had been announced in a Board press release that (foreshadowing the era of FOMC

postmeeting policy statements) described the connection between that rate decision and the outlook for inflation and

economic activity (see Crutsinger, 1991).

new material in the FOMC statement was envisioned as referring to a longer future horizon than

what the tilt had covered. Nonetheless, the change in communications also meant less explicit

guidance, for it implied that the FOMC announcement would no longer focus on the prospects

for the federal funds rate. Instead, the FOMC would refer to its goal variables alone, as “the

[balance-of-risks] announcement will indicate how the Committee assesses the risks of

heightened inflation pressures or economic weakness in the foreseeable future.”

But after the federal funds rate had been brought down to 1 percent and the FOMC felt that

clarification of the associated policy stance was needed, the Committee opted to institute explicit

interest-rate forward guidance.

133

The FOMC inserted into its postmeeting statement of August

12, 2003, the guidance that “the Committee believes that policy accommodation can be

maintained for a considerable period.”

134

7. Conclusion

This paper has traced the emergence of forward guidance as a monetary policy tool in the United

States. It has done so by ascertaining the attitudes toward public guidance about future monetary

policy—in particular, the future path of short-term interest rates—that prevailed among the

makers of U.S. monetary policy from the 1950s to the 1990s. It emerges from the analysis that,

though deployed only in recent decades, forward guidance was contemplated as a potential

policy tool by policymakers in the earlier eras. The premises underlying forward guidance

enjoyed wide acceptance from an early stage. It was understood that longer-term rates mattered

for aggregate private-sector spending and that these rates were a function of expected future

short-term rates. Nevertheless, policymakers resisted forward guidance for decades, until a

change occurred: the development of a consensus more favorable to the deployment of guidance.

As the above analysis indicated, policymakers of earlier decades suggested that little was known

in advance about what values of the short-term interest rate would be appropriate—and that

disclosing current policymaker thinking about likely future rates would trespass on the

prerogatives of future policymakers, who had the responsibility for the decisions bearing on

these rates.

135

These objections to forward guidance melted away in more recent decades.

Providing indications of policy intentions became regarded as useful, rather than as something

——————————————————————————————————————————

133

See, for example, Yellen (2013). See also Gürkaynak, Sack, and Swanson (2005) and Lunsford (2020) for

estimates on the effects on the expected short-term interest rate path of this early guidance and of the prior balance-

of-risks statement language.

134

Federal Open Market Committee (2003).

135

A further relevant factor was that—particularly during the era in which Paul Volcker was head of the Federal

Reserve—the idea of providing guidance regarding short-term interest rates conflicted with policymakers’ wish to

discourage perceptions that they set the level of short-term rates.

that preempted future policy decisions. It came to be accepted that the future rate path was not

entirely unpredictable and that policymakers consequently could provide useful information

about future settings of policy instruments—in contrast to their practice of describing future

monetary policy only in terms of hoped-for aggregate macroeconomic outcomes. These changes

in views on forward guidance were in keeping with a greater acceptance of the notion that a

policy strategy involved a path of the policy instrument over time, rather than a sequence of self-

contained individual decisions about instrument settings.

136

In addition, a possible result of

guidance—better alignment of market expectations of interest rates with policymakers’ views—

came to be seen as valuable and as likely to contribute to economic stabilization.

137

Another key objection regarding forward guidance that policymakers voiced until the 1990s was

that providing interest-rate projections would, in practice, be reminiscent of an interest-rate peg.

It was suggested that such projections would lock the FOMC into particular numerical values of

interest rates, even if the values given in the forward guidance turned out not to be those most

consistent with macroeconomic stabilization. This perspective made itself felt in the restricted

manner in which pre-1990s policymakers spoke about future interest rates: they largely confined

themselves to describing the longer-run operation of the Fisher relationship—thereby excluding

from consideration the additional, shorter time-frames for which monetary policy was also

relevant. Even in the early 1990s—when policy officials became more comfortable with the

notion of moving longer-term rates by signaling future moves—they tended to avoid mentioning

specific values of future short-term rates, instead referring to the reaction function. The advent

of forward guidance in the 2000s did, however, involve, in addition to official descriptions of the

policymaker reaction function, specific references to the likely path of short-term interest

rates.

138

In describing the rate path, policymakers forestalled perceptions that they were pegging

rates by stressing that the indicated path was conditional on an assumed economic outlook.

——————————————————————————————————————————

136

This change in perspective was, in turn, in conformity with developments in economic research noted by Sargent

(1987, p. xxi), who observed that best-practice policy analysis had moved from “attempting to analyze the effects of

one-time actions that are isolated in time” to “think[ing] of policymaking as a process producing a strategy.”

137

As discussed above, the Federal Reserve leadership before the forward guidance era occasionally became

unhappy with discrepancies that emerged between financial markets’ expectations of short-term rates and the

corresponding expectations held by policymakers. One such discrepancy evidently led Chairman Volcker to take

the then-unusual step in 1982 of providing explicit rate guidance.

138

Engen, Laubach, and Reifschneider (2015) argued that one reason for this was that some of the guidance

involved, in effect, the announcement of a changed reaction function. That being the case, it was useful to give

guidance that, by being explicit about the numerical values of short-term interest rates, was more likely to move

private-sector expectations of the rate path away from that implied by the assumption of a continuation of the

existing policymaker reaction function.

Finally, it is noteworthy that—although the advent of ELB episodes has certainly seen forward

guidance come into its own as a policy tool—the shift in Federal Reserve discussions toward

being more amenable to forward guidance occurred in the 1990s, before the ELB emerged as a

pressing concern. This aspect of the origin of FOMC guidance is keeping with the argument

made both in vintage discussions of forward guidance (such as Keynes, 1930) and in modern

discussions (such as Svensson, 2015) that such guidance is a natural tool of monetary policy and

should not be regarded as suitable for deployment only in ELB conditions.

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