BIS Says Forward Guidance Can Lead to Excessive Risk Taking

Central bank efforts to become more predictable on future interest rate moves have smoothed out short-term upsets in financial markets but could also lead to excessive risk-taking, research from the Bank for International Settlements said on Sunday.

Central bank forward guidance, whether publishing rate forecasts or promising rates will remain at certain levels for a given time or until certain economic conditions are reached, has been in the spotlight recently as economies recover from the financial crisis and investors try to pick the beginning of the end of easy money policies.

Research published in the BIS quarterly review found guidance from the Bank of England, European Central Bank and Federal Reserve had a calming influence on markets and also helped shield the UK and euro zone economies from turbulence last year about when the Fed slowing asset purchases.

But BIS economists said there were risks from markets focusing too narrowly on certain aspects of forward guidance and from central banks themselves potentially becoming too worried about markets’ reaction, to the extent that it could delay a return to more normal policy settings.

via Reuters

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