Overshooting targets needed

Central bank policy makers may provide threshold-based forward guidance about the future path of policy rates in the hope of boosting inflation at a time when they have run out of the traditional interest rate ammunition. That is the conclusion of a post on the Bank of England's blog site, Bank Underground.

Threshold-Based Forward Guidance (TBFG) means that the policymaker links their decision to raise the policy rate from zero, or the so-called lower bound, to outturns for particular macroeconomic variables, for instance inflation.

We show that TBFG can improve welfare at the lower bound by increasing expected future inflation and, unlike forward guidance based purely on calendar time, by shrinking the variance of possible outcomes for inflation around the target.

One advantage that TBFG has over other policies that have been proposed (like price level targeting) is that the thresholds can be specified in terms of variables that form part of existing remits (like inflation).  However, in order for TBFG to impart any stimulus it is necessary for policymakers to commit to overshooting their targets.

Another reason for the Czech National Bank, as well as other central banks grappling with unfavorably low inflation, not to rush to unwind unconventional policies.