Goldman Sachs - A Guide To Guidance

Economics, Commodities and Strategy Research
Top of Mind
October 31, 2013
Issue 18
A Guide to Guidance
From the editor: With the recent adoption of explicit forward guidance as a stimulative
policy tool by the major European central banks, virtually every major central bank is
now using the tool in some form. The potential benefits and dangers of such policies
have therefore become Top of Mind. We ask Professor Michael Woodford widely
regarded as one of the leading monetary economists whether the greater use of
guidance is a good thing. His answer: YES, but the form of the guidance matters. We
then lay out our take on why some central banks remain hesitant to fully embrace the
policy (concerns about inflation as well as tying their hands in an uncertain world), if
softer guidance can still be effective (somewhat, according to the Scandi experience),
why disconnects (Sep 18 taper NOT!) still happen (things change, making it hard to
sometimes follow through), whats better: asset purchases or forward guidance
(increasingly the latter), and what the market seems to prefer (deeds over words).
Inside
Source: wordle.com
Interview with Michael Woodford

Professor, Columbia University
The taper head-fake and whats next

Kris Dawsey, GS US Economics
Forward (mis)guidance?
Huw Pill, GS European Economics
Can words really equal deeds?

Robin Brooks, GS Global Markets
10
Efficacy of QE versus FG
Jari Stehn, GS US Economics
12
Lessons from forward guidance pioneers

Lasse Holboell Nielsen, GS European Economics
13
The issues raised by recent

policy experience concern the
means to steer interest rate
expectations, rather than the
desirability of doing so. And the
adoption of more explicit
communication to steer rates
remains justifiably controversial.
Its a mistake to view asset

purchases and forward guidance
as two alternative means to
providing further stimulus, so that
we can avoid having to say more
about future policy if instead we
are acting to make additional
asset purchases.
[In terms of implications for

rates] the jury is still out on how
well forward guidance works.
What is clear, though, is that
markets prefer deeds to
words.
Huw Pill
Michael Woodford
Robin Brooks
Editor:
ECS Executive Committee:
Allison Nathan | allison.nathan@gs.com | +1 (212) 357-7504 | Goldman, Sachs & Co.

Jeffrey Currie | Jan Hatzius | Kathy Matsui | Timothy Moe | Peter Oppenheimer | Dominic Wilson
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification,
see the end of the text. Other important disclosures follow the Reg AC certification, or go to
www.gs.com/research/hedge.html.
The Goldman Sachs Group, Inc.
Goldman Sachs Global Investment Research
Top of Mind
Issue 18
El
Macro news and views

We provide a brief snapshot on the most important economies for the global markets
US
Japan
Latest GS proprietary datapoints/major changes in views
The cumulative weakness in the labor market over the last

three months has led us to push back our expectations on the
announcement of tapering to the March 2014 FOMC meeting.
We revised our $/JPY forecasts slightly lower on October 10

given a lack of near-term catalysts for a weaker Yen.
We still expect growth to pick up from 1.6% in 2013E to 2.9%

in 2014E; the ISM indices are in strongly expansionary territory.
Datapoints/trends were focused on
The potential for more disruption around fiscal deadlines: (1)

December 13: targeted conclusion of House-Senate budget
negotiation, (2), January 15: expiration of spending authority, (3)
Mid-March: likely debt limit deadline.

The national CPI that excludes fresh foods and energy pulling
out of negative territory in September for the first time since
December 2008.
A rise in household current conditions sentiment in September
for the first time in six months on favorable auto sales and a pretax-hike rush in demand.
US manufacturing on the rise
Japanese non-energy prices (finally) on the rise
US ISM manufacturing index
Core-core CPI (excludes fresh foods and energy), yoy %chg
60
1.0
58
0.5
56
0.0
54
Sep
-0.5
52
-1.0
Energy contribution
50
Non-energy contribution
National core CPI
2011
2010
48
Jan
May
Sep
Jan
2012
May
Sep
Jan
2013
May
Sep
Jan
-1.5
May
11/1
Sep
Source: ISM, Goldman Sachs Global Investment Research.
11/7
12/1
12/7
13/9
13/7
13/1
Source: MIC.
Euro Area (EA)
Emerging Markets (EM)
We now expect the ECB to offer a longer-maturity LTRO, which

we believe would be constructive for the banking sector and
the economy during 1H14 rather than by the end of the year.
China growth tracking around 9% as measured by our Current

Activity Indicator (CAI).
Rising concerns about another liquidity squeeze in China.
The euro has appreciated around 1% since the ECBs October

meeting, which adds to the downside risks to growth and
increases the chance of a rate cut, but we do not expect action
beyond a potential mention of concern at the Nov meeting.
Spain exiting recession, leaving GDP 7.4% below its 2008 peak.
Continued declines in Brazilian industrial sector confidence to

the lowest level since July 2009 despite recent depreciation in
the BRL; Mexico has also converged to the sluggish growth
path of Brazil, but is better positioned to provide stimulus
(further rates cuts) given its much more benign inflation.
Spain (finally) growing again
Inflation deviation (Mexico vs. Brazil)
Spain GDP, %
% of CPI above inflation-targeting-midpoint, 3mma
10
2.0
80
1.5
BRA
70
MEX
1.0
4
0.5
60
3Q
0.0
-2
-0.5
-4
50
40
-1.0
-6
30
qoq (rhs)
-8
-10
97
98
99
00
01
yoy (lhs)
02
03
04
-1.5
05
06
07
Source: INE.
08
09
10
11
12
13
-2.0
20
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Source: Haver Analytics, Goldman Sachs Global Investment Research.

2
Top of Mind
Issue 18
El
A Guide to Guidance
As we approach the five-year anniversary of the US Federal
Reserve Board lowering US policy rates to their effective zerobound in the midst of the Global Financial Crisis, central banks
across the developed market economies faced with generally
improving but still-anemic growth continue to look to
unconventional policy tools to further stimulate their economies.
talk about future policy intentions), and why the market and the
Fed have seemed so disconnected at various points this year
despite substantial attempts by the Fed to communicate more
clearly (there were mistakes in communication, but that does not
mean the situation would have been better if the Fed had instead
kept its mouth shut, especially in such unprecedented times.)
The use of explicit forward guidance is one of these tools, which

has been used by the Bank of Japan and other central banks for
some time and has been a crucial part of the Feds post-crisis
policy strategy, evolving from vague qualitative guidance in
December 2008 to more explicit calendar guidance in August
2011 (which committed to low rates until at least a certain date),
and to threshold guidance in December 2012, (which committed
to low rates until specific economic conditions were met).
We then provide our take on these questions. Our chief European

economist, Huw Pill, looks at why some central banks remain
reluctant to embrace forward guidance especially on the
European side of the pond and thus have adopted softer forms of
it. But Lasse Holboell Nielsen, also of our European economics
team, uses the Scandi experience with explicit but conservative
forward guidance to suggest that softer forms can still be effective
in shaping policy expectations, with lessons for the ECB.
In recent months, both the European Central Bank (ECB) and the
Bank of England (BOE) also began experimenting with explicit
forward guidance as a stimulative policy tool, marking a not entirely
new but important shift in approach given these central banks
substantial reluctance to adopt such policies in the past. With
various forms of forward guidance now being implemented by
virtually every major central bank, the potential benefits and
dangers of such policies have become Top of Mind.
Jari Stehn of our US economics team then looks at the evolution of

the use of asset purchases versus forward guidance, with external
and our own analysis increasingly favoring forward guidance as a
policy tool. And Kris Dawsey, also of our US economics team, drills
down into the disconnect between the market and the Fed around
the September 18 FOMC meeting when the market was clearly
surprised by the Feds decision not to taper concluding that
things had changed sufficiently heading into the meeting to give
the Fed pause in following through with the expectations it had
largely created for itself.
We interview Michael Woodford, a professor at Columbia

University whose seminal paper presented at the Jackson Hole
central bank conference in August 2012 was thought to
substantially influence the Feds September 2012 adoption of QE3.
We ask if the greater use of forward guidance is a good thing (yes,
it can reduce misinterpretations of policy and enhance its
stimulative effect), if threshold guidance is better than
calendar guidance (yes, because it is ultimately more credible), if
the softer version of forward guidance adopted by the European
central banks will negate its effectiveness (yes, to some degree),
how he thinks about asset purchases versus forward guidance (its
a mistake to think of asset purchases as a way to avoid having to
Finally, Robin Brooks of our global markets team looks at market

implications of these policies, with past experience in the US and
Canada suggesting that deeds still speak louder than words.
Allison Nathan, Editor

Email: Allison.Nathan@gs.com
Tel:
212-357-7504
Goldman, Sachs & Co.
The evolution of central bank communication/transparency

Fed, Mar-93
Begins
releasing
minutes of
FOMC
meetings
(with 68
week lag)
Fed, Nov-93
Begins
releasing
transcripts
of FOMC
meetings
(with 5 year
lag)
Central
bank policy
intentions
shrouded
in secrecy
BOJ, Jan-98
Monetary
policy
meeting
begins on a
monthly
scheduled
basis (adhoc before)
Fed, May-99
Releases a
statement
about the
FOMC
decision
even after
no change in
federal funds
rate target;
Begins
BOJ, Apr-98 announcing
Introduction policy tilt
indicating
of Bank of
most likely
Japan law
that clearly future
sets out the interest rate
action
dual
mandate of between
sustainable then and the
next FOMC
growth
under price meeting
stability
Fed, Feb-94
Begins
explicitly
announcing
changes in
federal funds
rate target
1993
1994
BOE, Feb-93
Publishes first
Inflation
Report
1995
1996
1997
1998
BOE May-97
BOE granted full
independence
and MPC
established
Fed, Jan-00
Commits to
publishing a
statement
after every
FOMC
meeting;
Replaces
tilt with
statement
describing
balance of
risks to
economic
outlook
intended to
cover an
interval
extending
beyond the
next FOMC
meeting
Fed, Mar-02
Begins
releasing
votes of
individual
Committee
members
and
preferred
policy choice
of any
dissenters
1999
2000
2001
2002
BOJ, Oct-00
Begins
publishing
report on
growth and
BOJ Mar-01
inflation
Initiates
outlook
outcome-based
ECB, Jan-99
guidance for its
Begins conducting
rate policy
monetary policy,
which includes
some aspect of
forward guidance
in its "intention to
maintain a 3%
MRO rate for the
foreseeable future"
RBZ, Jun-97
Begins
announcing its
forecast of
future shortterm interest
rates
BOE, Jun-98
Bank of England
Act formalizes
BOE, Oct-98
independence
BOE MPC
expedites release
of Minutes from
5 weeks to 2
weeks (13 days)
Fed, Feb-05
Expedites
the release
of FOMC
minutes to
make them
available
before the
subsequent
FOMC
meeting
Fed, Aug-03
Begins to
issue direct
qualitative
statements
about its
future policy
inclinations
in various
verbal
formulations
2003
2004
Fed, Nov-07
Increases the
frequency and
expands the
content and
horizon of its
publiclyreleased
inflation and
economic
activity
forecasts
BOJ, Mar-06
Introduces the
"understanding of
medium-to-long-term
price stability" in
numerical form (0-2%);
Introduces the "two
perspectives
approach" that
considers the dual
mandate as well as an
assessment of risk
2005
2006
2007
Riksbank,
Feb-07
Begins to
Norges Bank,
regularly
Nov-05
release
Begins to regularly forecasts of
release forecasts the future
of the future path path of their
of their policy rate, policy rate
2-3 years ahead
BOJ, Oct-03
Makes the
conditions for an
exit from QE more
transparent,
providing three
conditions that
must be satisfied
before ending QE
Central
Bank of
Iceland,
Mar-07
Begins to
regularly
release
forecasts of
the future
path of their
policy rate
BOJ, Jul-08
Announces: (1)
The release of
statement
explaining their
latest
assessment of
the economic
and price
situation after
every meeting
(not just those
when interest
rates are
changed) (2)
The October
semi-annual
economic and
price outlook
will release
forecasts for a
longer time
horizon
ECB, Jul-13
Introduces
forward
guidance not new in
its history
but a
significant
Fed, Aug-11 step away
Shifts to
from the
calendarmantra "we
based
never preguidance
commit" that
from vague Trichet
qualitative
established
guidance
Fed, Apr-11
Chairman
holds first
press
conference
following a
FOMC
decision
Fed, Dec-12
Replaces
calendar-based
guidance with
outcome-based
guidance
("thresholds)
2008
2009
2011
2012
2010
2013
BOC, Apr-09
Initiates calendar- BOJ, Feb-12
(3) Risk
Sets
inflation
based guidance,
balance charts
conditional on the "goal"
will be
inflation outlook
published more
BOE, Mar-13
frequently (4)
Remit adjusted
Release of
to further
minutes will
formalize
always be
inflation/growth
before the
flexibility; BOE
subsequent
invited to
meeting (5)
consider forward
Monthly
guidance
economic
assessments
in Japanese
will be
BOE, Aug-13
released the
Introduces
day after the
outcome-based
Board meets
forward guidance
(English
(first time it has
version two
used forward
days after)
guidance of any
kind)
Red = Fed
Purple = ECB
Blue = BOJ
Green = BOE
Orange = Notable innovators/ others
Source: Goldman Sachs Global Investment Research.

Top of Mind
Issue 18
El
Interview with Michael Woodford

Michael Woodford is the John Bates Clark Professor of Political Economy at Columbia University.
His paper Methods of Policy Accommodation at the Interest Rate Zero-Bound presented at
Jackson Hole in August 2012 was widely regarded as the seminal paper at the central bank
conference. Below he discusses the benefits of forward guidance, even if it is no panacea.
The views stated herein are those of the interviewee and do not necessarily reflect those of Goldman Sachs.
Allison Nathan: Havent central banks
always tried to influence interest rate
expectations? What is so special
about forward guidance today?
Michael Woodford: No, central banks
have not tried to do things that were at
all similar to this in the past. Until quite
recently, all central banks were very
reluctant to say things in advance
about future policy decisions, and this
reluctance remains to varying degrees at
many banks. The forward guidance
adopted by the Fed and other central
banks, which tries to influence
expectations by actually saying things about policy intentions, is
therefore a new policy tool and indeed one that has become more
important given the near-exhaustion of the most traditional policy
tool adjusting policy rates as rates across the major economies
already hover around their effective lower bound.
Allison Nathan: What are the benefits of forward guidance?
Michael Woodford: If policy expectations matter and I think it is
pretty clear that they are crucial to how longer-term assets end up
getting priced then there are two kinds of advantages of explicitly
discussing future policy by the central bank. One advantage is that
it can reduce misunderstandings about policy intentions,
which, in turn, can reduce uncertainty for the central bank about
the effect of its policy on the markets. In principle, talking directly
about policy intentions would allow the use of more complex
policies, which might not otherwise be pursued for fear that they
would not be understood without explanation. The second general
type of gain from explicitly talking about future policy is to help
ensure that the policy committee itself will follow through
with its commitments even though it may have motives to depart
from them later on.
Both of these potential advantages are particularly clear when you
reach an effective lower bound on policy rates. At that point,
convincing people that the policy rate will remain lower for
longer can help ease financial conditions today, providing
additional stimulus to the economy when traditional tools no longer
can. But talking about the intention of lower for longer is crucial
because being at this lower bound is a very unusual situation,
so there is little past experience that people can look to in
order to anticipate how the central bank is going to respond.
There is also a clear need for the central bank to commit itself in
advance in order to achieve the stimulative benefit. That is because
of course later when the stimulus has worked and the economy
is improving - the bank will have little motivation to actually keep
rates low (the so-called time inconsistency problem) unless they
committed to do so in advance. To overcome that problem, the
central bank needs to make an explicit promise that would be
difficult or embarrassing to just completely ignore later.
Allison Nathan: What are the dangers of forward guidance?
Michael Woodford: The most obvious danger, which has likely

been the main reason for central banks reluctance to talk about
future policy in the past, is the possibility that a policy
commitment that looks sensible at some earlier time turns out
to be unwise because things happen in the meantime that the
central bank did not expect. Those costs can be reduced without
losing all of the potential benefits of forward guidance if the central
banks think carefully about what kind of commitments about future
policy should be made. It makes sense to avoid unnecessary
specificity about things that do not need to be specified too
precisely in order to achieve the desired change in expectations.
For example, in the case of a commitment to keep the federal
funds rate low for longer in order to stimulate the economy today,
the central bank could make a very specific commitment about the
path of the policy rate over time. But there would be much more
likelihood of embarrassment in that case than if the bank instead
committed to keep rates low until certain economic conditions
arise, whenever that may be.
Allison Nathan: The BOE and the ECB have said that the
intention of their shift to forward guidance has been to clarify
their policies rather than to commit to lower for longer. Will
this approach negate the benefits of the guidance?
Michael Woodford: Yes, to some degree. In the case of the Bank
of England, the structure of their statement with several so-called
knock-out provisions - as well as their insistence that the
statement was nothing more than a clarification of the BOEs
normal reaction function, has given people little reason to change
their prior beliefs about how soon the Bank would raise rates.
Because of this, the statement does not seem to have moved
market expectations much and in the way that the BOE thought it
should. Similarly, the ECB has taken small steps towards doing
something that you might think of as forward guidance, but has
also done so quite hesitantly; they are also inclined to deny that
they are committing themselves at all about future policy. Given
the aversion to talking about policy intentions in the past, this
hesitation is not surprising, nor is the fact that even central banks
that have decided that they should experiment with the policy do it
in a way that simultaneously denies that they would ever do it,
because it goes against their instincts. But that to some extent
defeats the purpose of the policy. Their approach is quite
different from that of the Fed, which has more clearly embraced
the policy of lower for longer.
Allison Nathan: Is the Feds shift to outcome-based or
threshold guidance from calendar guidance a good thing?
Michael Woodford: Yes, because threshold guidance is
ultimately more credible. The problem with calendar-based
guidance is that if there is a real promise to keep rates at a certain
level until a certain point in time no matter what happens, it would
be a pretty reckless policy. And because the policy would be
reckless, it would ultimately be hard to believe. That would be the
case unless the central bank restricted itself to a short horizon over
which there could not be many surprises. But if the horizon is too
short, the impact on future expectations would be small. So I think
4
Top of Mind
Issue 18
El
the possibility of making a commitment that extends far enough

into the future for it to be news about future policy that would
significantly matter to asset pricing is much more plausible if it is
based on economic conditions rather than just based on a date.
Allison Nathan: There have been several instances when the
use of forward guidance has had an opposite impact than the
central banks intended why?
Michael Woodford: The use of forward guidance is not some kind
of magical tool where the mere fact that the central bank says
something means that people will then think exactly that. A central
bank needs to give people a reason to think something new or
different about what it is going to do. A critical part of effective
policy is therefore understanding what people will think they
are learning about the banks policy. An example of this that I
talked about in my Jackson Hole paper last year was the
experience of the Swedish Riksbank in April 2009, when they cut
their policy rate to 50 basis points and accompanied this with a
statement and a published projected rate path that showed policy
rates remaining at 50 basis points - the lowest level ever - until the
beginning of 2011. To the Banks surprise, market forward rate
expectations rose rather than fell following the announcement.
Why? Because the big news of the statement was not the
central banks lower projected rate path, which was in any case
just a projection and not a commitment, but that the central bank
was apparently regarding 50 basis points as a floor, which was
higher than at least some market participants had previously
guessed. That news shifted the markets most likely expected path
of the future policy rate up rather than down.
Allison Nathan: How would you explain the violence of the
bond market selloff in May/June, which came in response to a
very small change in the Fed's message?
Michael Woodford: I am inclined to think that it indicated some
mistakes in Fed communication prior to May that led to two
possible types of misinterpretation about the Feds intentions.
First, some people may have interpreted the start of taper talk as
a signal that the Fed was trying to withdraw accommodation more
broadly, and was also preparing to start raising interest rates. That
was a surprise to the FOMC; they didn't think they were saying
anything that would suggest they were preparing to raise rates.
But they had left themselves open to that misinterpretation by
failing to explain earlier the criteria that would determine the path
of asset purchases in a way that sounded very different from the
criteria that would determine the path of interest rates. The
forward guidance about both asset purchases and interest rates
focused on labor market conditions and sounded very closely
related. I do not think that the Fed meant for the criteria to be the
same, but they failed to sufficiently explain why they would not be.
Second, there may have been a number of people who thought the
purchases were going to continue at the current rate for a lot
longer, and learned suddenly that they would not. If that was news
to people, it was again a failure of communication because I doubt
that the Fed had ever thought asset purchases would continue at
the current rate beyond 2013. Despite these failures, it would be
a mistake to conclude that the Fed should not have started
speaking about tapering when it did; the problems would not
have been avoided if the Fed had just kept its mouth shut, because
the misinterpretations would still be there. And shutting your
mouth is potentially setting you up for an even harder adjustment
later when the misinterpretations must eventually be exposed.
Allison Nathan: Why was the market so surprised by the
decision not to taper at the September FOMC?
Michael Woodford: It certainly seemed to me that during the

summer the ground was being prepared for a slowing of the rate of
purchases. As to why they did not actually do it, I think it was a
reaction to the fact that the market had responded to those earlier
hints more violently than expected. And there was evidently a
decision that they could not risk a further unexpected negative
reaction to an actual announcement of tapering. That was probably
a mistake in judgment. By September, a modest reduction in
purchases was widely expected, so I do not think there would have
been a big negative reaction to that announcement. But, by
blinking when they did, I fear that they have made a negative
reaction more likely in the future, because they are now back to
square one, with people once again lacking a clear sense of how
close the Fed is to tapering and thus vulnerable to surprise.
Allison Nathan: Is there actually greater volatility and
uncertainty in the markets as a function of this desire to
communicate more, but not quite getting it right?
Michael Woodford: I don't think so, because the question is: what
would be people's understanding of policy if the Fed had not tried
to talk about it at all? There would be a lot of uncertainty if the Fed
were adopting a policy of silence, especially given that we are in
unprecedented territory. When conditions are unusual is exactly
the time when trying to provide some explicit guidance is
potentially most valuable, even if it is not a panacea.
Allison Nathan: How important are asset purchases as a signal
of commitment to accommodative policy?
Michael Woodford: I think that a lot of the effects of asset
purchases have been signaling effects. The advantage of
purchases as a signal is that it is something that people see being
done. It's not just talk, so it grabs peoples attention. And the fact
that action is being taken gives some indication of where the
majority of the FOMC stands. But the likelihood that purchases
have had some signaling effect does not necessarily mean that
they are the most effective way of providing the signals that the
central bank wants to send. There has at times been a temptation
to view asset purchases and forward guidance as two alternative
means to providing further stimulus, so that we can avoid having to
say more about future policy if instead we are acting to make
additional asset purchases, and I think that is a mistake. To the
extent that the main goal of purchases is to give a signal, then you
should think consciously about what signal you are trying to give
and be comfortable delivering that signal. Thinking about asset
purchases as part of a coherent and consistent attempt to give
signals about future policy is one thing. But it's very different from
the idea that there will be a mechanical effect of purchases that
allows you to avoid saying anything about future policy intentions.
Allison Nathan: Whats next for Fed communication?
Michael Woodford: It would be valuable for the Fed to provide
more guidance about the process of policy normalization. When
it is clear that they will begin slowing the rate of asset purchases -which I think will have to be fairly soon, although not necessarily
this year given that they did not do it in September -- the next
obvious question will be how quickly the rest of the unusually easy
policies will be unwound, and what the broader 'exit strategy' will
look like. The last time they spoke about that was in 2011 and its
pretty obvious that what they said then is no longer an operative
strategy. They will need to say something about that at least by the
time that they start tapering, because at that point it will be very
clear that we are no longer in a period of just staying the course.
But a likely reason not to make big statements right now is of
course the imminent hand-off of the Chairmanship in January.
5
Top of Mind
Issue 18
El
The taper head-fake and whats next

Kris Dawsey of the GS US economics team
addresses the September 18 taper head-fake,
the future of forward guidance, and Yellen
At the September FOMC meeting, the Fed unexpectedly decided
not to reduce the pace of its asset purchases. This followed
several months of the Fed seeming to communicate that it was
setting up for a taper. The surprise decisionon top of surprisingly
dovish signals on the forward path of the fed funds
rateprompted an 18 basis point drop in the 10-year Treasury yield
from just prior to the announcement to the afternoon close. In this
(relatively new) era of the Fed and other central banks heralding
transparency and going to ever-greater lengths to communicate
their intentions, the key question is: why was the market caught
so off guard?
What not tapering looked like

US 10-year treasury yields, %
2.95
2.90
September 18
FOMC Statement
2.85
2.80
2.75
2.65
9/16/2013 9:05
9/16/2013 10:50
9/16/2013 12:35
9/16/2013 14:20
9/16/2013 16:05
9/16/2013 20:50
9/16/2013 22:35
9/17/2013 0:20
9/17/2013 2:05
9/17/2013 3:50
9/17/2013 5:35
9/17/2013 7:20
9/17/2013 9:05
9/17/2013 10:50
9/17/2013 12:35
9/17/2013 14:20
9/17/2013 16:05
9/17/2013 20:45
9/17/2013 22:30
9/18/2013 0:15
9/18/2013 2:00
9/18/2013 3:45
9/18/2013 5:30
9/18/2013 7:15
9/18/2013 9:00
9/18/2013 10:45
9/18/2013 12:30
9/18/2013 14:15
9/18/2013 16:00
9/18/2013 20:45
9/18/2013 22:30
9/19/2013 0:15
9/19/2013 2:00
9/19/2013 3:45
9/19/2013 5:30
9/19/2013 7:15
9/19/2013 9:00
9/19/2013 10:45
9/19/2013 12:30
9/19/2013 14:15
9/19/2013 16:00
9/19/2013 20:45
9/19/2013 22:30
9/20/2013 0:15
9/20/2013 2:00
9/20/2013 3:45
9/20/2013 5:30
9/20/2013 7:15
9/20/2013 9:00
9/20/2013 10:45
9/20/2013 12:30
9/20/2013 14:15
9/20/2013 16:00
2.70
Source: Bloomberg.
There are at least a couple of potential explanations. First,

conditions had deteriorated heading into the meeting. Data
surprises were generally negative in August and the first part of
September. Although the market could also observe this
deterioration, it was faced with the challenge of discerning the
degree to which the Fed was focused on the weaker latest month
or two of data, versus the cumulative improvement in the data
since QE3 was introduced, as some communications had
emphasized. As it turns out, the Fed seemed to place more
emphasis on the former than the market expected, with the
meeting minutes explicitly singling out the disappointing July and
August payroll reports as a cause for concern. Worries about the
upcoming fiscal deadlines and potential downside risks to the
economic outlook also seemed to grow, with the situation arguably
just beginning to look more uncertain in the days leading up to the
meeting.
Second, in the context of growing unease about the cyclical
indicators and the fiscal situation, the fear that a decision to taper
might further tighten financial conditions and in particular,
increase mortgage rates apparently gained greater prominence.
This concern was amplified by the fact that the Committee was
unable to come to an agreement at the September meeting on
how they might enhance or clarify forward guidance to offset the
potentially more hawkish signal of tapering. The possibility that
further forward guidance might not be as credible in light of the
upcoming transition in Fed leadership was also mentioned. On net,

some things had changed since the Feds earlier
communications, which the Fed seemed to give more weight
to than the market, but the Fed also seemed uncomfortable
following through with the expectations it had largely created
for itself amid the cyclical and market uncertainty.
What next for guidance?
We expect the Fed to ultimately enhance its forward guidance
when it chooses to taper asset purchases, at this point most
likely at the March 2014 meeting. It is also possible that they
choose to adjust the guidance before tapering. Possibilities include
a clarification that the current threshold of 6.5% unemployment
that must be met to consider a shift in policy rates only applies if
the committee's near-term inflation forecast is at the target and a
lower threshold would apply if inflation remains below target, an
outright inflation floor, or an outright reduction in the
unemployment threshold. Such changes would be in line with
outcomes suggested by a number of Fed officials, including
Bernanke himself at the last post-FOMC press conference. But
what Chairman Bernanke does or does not support is quickly
becoming less important in light of the imminent transition in Fed
leadership at the end of January.
The real question: Yellen
The real question is what will now-Vice Chair Janet Yellen support,
provided she is confirmed as we expect? We think that the
Yellen Fed will be similar to the Bernanke Fed in terms of its
overall policy stance. Janet Yellen has spoken very favorably of
the value of forward guidance in the past, calling economic
outcome-based thresholds for raising rates a major
improvement. As head of a Fed committee on revamping
communications policy, Yellen has shown herself to be a fan of
increased transparency. Perhaps most importantly, she has on
several occasions shown simulations of optimal monetary
policy illustrating the unemployment rate falling below the
current 6.5% threshold before rate hikes begin. For these reasons,
we think she will be supportive of enhancing forward guidance, if it
does not occur before she takes the helm at the March meeting.
It is also likely that Yellen will support reducing the pace of asset
purchases in measured steps, rather than rapidly, if for no other
reason than the likelihood that QE helps to enhance forward
guidance as demonstrated by volatility in front-end rates
following the start of taper talk in June although she has also
spoken favorably in the past about the efficacy of QE in its own
right.
DID YOU KNOW?

Although the rates market was caught substantially off guard
by the FOMCs September 18 decision not to taper, the gold
market seemed far less surprised by the decision. Gold prices
had risen steadily heading into the meeting consistent with
more dovish expectations that have historically lent support to
the metal, which is traditionally considered a store of value.
Gold prices therefore saw a much more muted rally than did
rates post the decision, helping to close the large valuation gap
that had opened up between the assets over the prior month
(see page 13).
Kris Dawsey, US Economist

Email:
Tel:
Kris.Dawsey@gs.com
212-902-3393
Top of Mind
Issue 18
El
Forward guidance explained

Responsible central bankers committing to be irresponsible
The goal of forward guidance is to steer market, as well as public, expectations about the future path of monetary
policy. This guidance can take many forms, including (1) an explicit forecast for future interest rates, which the
Riksbank and some other central banks publish; (2) a simple statement of an intention to keep interest rates low for
some unspecified period, such as an extended period; (3) calendarbased guidance that commits to keeping rates
low until at least a specific point in time; and (4) outcome-based guidance that establishes specific economic
thresholds that must be met before considering a shift in monetary policy, as has been adopted more recently by the
US Federal Reserve (in December 2012 ) and the Bank of England (in August 2013).
Calendar and threshold-based guidance are not necessary to achieve the goals of forward guidance. But these forms
of guidance can have an additional feature that weaker forms of forward guidance do not share: in publicly committing
to keep interest rates at their effective floor until observable parameters are breached, a central bank is voluntarily
tying its own hands and, in doing so, can provide additional stimulus.
The logic of such an approach comes from the fact that spending in the economy today depends partly on
expectations of both future real interest rates and future spending. Therefore, if a central bank can credibly commit to
maintaining low interest rates beyond the point where it would normally choose to raise rates, the expectation of such
irresponsibly dovish behavior in the future can help to stimulate growth today. The problem is that, given the
conservative nature of central bankers, it is difficult for them to credibly commit to being irresponsible in this way: once
growth and inflation begin to rise, they will want to renege on their initial commitment and start to raise interest rates.
The public announcement of calendar-based guidance or thresholds can act as a disciplining mechanism to ensure
that they remain irresponsible in the future.
Central bankers and academics describe this as the optimal control approach to monetary policy choosing a
path for interest rates which best meets its objectives over several years as a whole (for the Federal Reserve that
means best fulfilling its dual mandate of full employment and price stability), even if this means committing to a policy
that is suboptimal at future points along that path.
The costs and benefits of adopting an optimal control approach to monetary policy is one that has been discussed
more extensively in the US than in Europe. And, indeed, Fed officials appear to have leaned more in the direction of
this approach than other central banks. In particular, the optimal control perspective has been discussed in a series of
speeches by Janet Yellen, the Vice Chair of the Federal Reserve who was recently nominated to succeed Chairman
Bernanke when he steps down in January 2014.
The accompanying exhibits simulate the differences for the economy under an optimal control path for policy and the
path projected by the FOMC in its September 2013 Summary of Economic Projections. Under the optimal control
approach the funds rate stays on hold for longer (until early 2016), unemployment falls more sharply and inflation is
allowed to overshoot the 2% goal temporarily.
Federal Funds Rate

%
4.5
4.0
3.5
8.5
Baseline*
Optimal Control
3.0
2.5
2.0
1.5
Headline PCE Inflation
Unemployment Rate
%
8.0
% chg, year ago
Baseline*
Optimal Control
7.5
7.0
2.5
2.0
Baseline*
Optimal Control
1.5
6.5
6.0
1.0
5.5
0.5
5.0
0.0
2012 2013 2014 2015 2016 2017 2018 2019 2020
4.5
2012 2013 2014 2015 2016 2017 2018 2019 2020
1.0
0.5
0.0
2012 2013 2014 2015 2016 2017 2018 2019 2020
* Based on the September 2013 Summary of Economic Projections.

Jari Stehn and Kevin Daly
Top of Mind
Issue 18
El
Forward (mis)guidance?
Huw Pill, Chief GS European Economist,
discusses the concerns about forward
guidance that seem to be generally greater on
the European side of the pond
The Federal Reserve was an early and enthusiastic adopter of
explicit forward guidance for monetary policy. By contrast, the
leading central banks in Europe initially showed greater reluctance.
Indeed, for some time, the mantra of ECB President Mario Draghi
(and, before that, his predecessor Jean-Claude Trichet) had been
we never pre-commit on the future path of policy interest rates.
More recently, attitudes have evolved. Over the summer, both the
ECB and the BOE officially adopted their own forms of forward
guidance. But, crucially, European policymakers have been at pains
to point out that their guidance should be interpreted as a vehicle
for better explaining their existing policy framework, rather than as
a shift in the strategic framework itself.
In particular, European central banks have avoided giving the
impression that they would be prepared to hold policy rates
lower for longer than would normally be expected, in an
attempt to ease financial conditions by flattening the yield curve to
a greater than usual extent. Such an approach has been advocated
by some as a way of obtaining additional monetary easing when
(short-term) policy rates reach their zero lower bound.
The objections
The main objection to the pursuit of such a policy is that it
would not be time consistent. In other words, once
macroeconomic conditions began to normalize for example, as
slack is eroded by stronger growth and inflation threatens to rise
the central bank would have an incentive to raise rates regardless
of its previous guidance in order to achieve its stabilization
objectives.
Two consequences could arise from the adoption of such a time
inconsistent approach. On the one hand, it may undermine the
effectiveness of the forward guidance program itself. Because
market participants understand that central banks will want to
renege on its promises in the future, they will not believe the
guidance offered at the outset. This lack of credibility implies that
market expectations will not be influenced by the announcement of
guidance, and therefore the desired flattening of the yield curve
and associated financial easing will not happen.
On the other hand, should the monetary authorities actually deliver
policy interest rates that were lower for longer than normally
required to stabilize the inflation outlook at target, it is natural to
expect that the inflation rate will rise, possibly to undesired
levels. Of course, this may simply represent a short-term
overshoot of the inflation objective. But should longer-term inflation
expectations be destabilized in the course of the overshoot, the
deviation from target is likely to prove more persistent and more
costly to correct.
Central banks in Europe may be particularly concerned about these
issues. For example, given the specific institutional context in the
Euro area, the monetary policy decision making process may find it
more difficult to follow through on guidance offered in the past.
Moreover, in many European countries with a recent history of
more elevated inflation, the perceived threat of destabilizing longerterm inflation expectations could be greater than in the United
States, where the Federal Reserve has built up a strong reputation
over many years.
Related concerns about forward guidance stem from the difficulties

policy makers may face in emphasizing the conditional nature of
that guidance. Markets could interpret forward guidance as a
concrete and irrevocable commitment by the central bank
regarding its policy interest rate path. But central banks need to
retain some discretion to vary policy rates (both immediately and
into the future) as circumstances change unexpectedly (or, in
economic jargon, shocks occur). It is this conditional response to
shocks that imparts monetary policy with its stabilizing properties
for the economy.
Afraid of the consequences in terms of market reaction and/or
volatility that could derive from a central bank failing to deliver on
its (mis)perceived unconditional commitment via forward guidance,
policy makers may cling to the satisfaction of previous guidance,
even when changes in economic considerations dictate otherwise.
This will lead to policy mistakes. Forward guidance can box a
central bank in to an inappropriate policy.
Thresholds not a cure-all
The Federal Reserve has tried to manage this concern by
emphasizing the conditional nature of its forward guidance through
announcing economic thresholds that would trigger a potential reevaluation of the guidance and the interest rate decisions that
derive from it. In particular, the Fed has announced thresholds in
terms of the unemployment rate.
But this is not a cure-all. Concerns about this approach stem from
two sources. First, it is unlikely that any single summary
variable be it unemployment or another indicator can
adequately capture the potential impact of all the factors that
should trigger a reassessment of the forward guidance policy.
For example, in practice the Federal Reserve has faced some
challenges arising from fluctuations in the US labor market
participation rate, which have reduced the unemployment rate
more rapidly than they may originally have expected.
Second and, in the eyes of many European monetary policy
makers, more importantly introducing thresholds for real
variables such as unemployment can distract the attention of
both policy makers and financial markets from the central
banks underlying mandate to maintain price stability.
Nothing new
Central banks throughout the world recognize that expectations of
future settings of policy interest rates exert a powerful influence
over financial conditions and thus over the economic outlook.
Guiding interest rate expectations is therefore a crucial
arguably, the crucial channel of monetary policy
transmission in most modern views of how the economy works.
As such, all central banks are engaged in forward guidance,
understood as efforts to steer interest rate expectations. Forward
guidance is therefore nothing new: the issues raised by recent
policy experience concern the means to steer interest rate
expectations, rather than the desirability indeed, necessity of
doing so. And the adoption of more explicit communication to steer
rates, potentially in ways that deviate from normal behavior once
the economy reaches the zero lower bound for nominal rates,
remains justifiably controversial.
Huw Pill, Chief European Economist

Email:
Tel:
Huw.Pill@gs.com
+44(20)7774-8736
Goldman Sachs International
Fed FOMC
Publishes a short press release containing the FOMC decision, a concise (and typically stylized) explanation of its
underlying reasoning, and (at times) forward guidance

Governor holds a press conference with Q&A immediately following policy decisions
Releases Minutes on an expedited timeline, before the subsequent meeting
Releases recorded votes (dissents are less frequent, connoting fundamental disagreement)
Publishes inflation and economic activity forecasts - out three years - four times per year (every other meeting)
Publishes a semiannual Monetary Policy Report to the Congress, presented with the Chairman's testimony to Congress
B en B ernanke, Go verno r
US Federal Reserve
So urce: US Federal Reserve
Generally pursues an individualistic communication strategy through inter-meeting speeches and commentary by
ECB GC
Publishes a short press release containing the GC decision, explanation of its underlying reasoning, and (at times)
individual members, which at times reveals highly diverse opinions across FOMC members
forward guidance
Governor holds a press conference with Q&A immediately following policy decisions; Press conference is generally less
detailed than the Minutes of the BOE or the Fed; does not provide any information on voting
Does not release Minutes
Does not release votes (decisions generally made in a consensual way)
Publishes projections of inflation and economic growth - up to two years ahead - four times per year (March, June,
September, December)
M ario Draghi, P resident
Euro pean Central B ank
So urce: Euro pean Central B ank
Publishes a Monthly Bulletin one week after each monetary policy meeting that contains an assessment of economic
developments and information on the analytic framework used in its decision-making process
Provides an annual report and testifies before Parliament
Generally displays a relatively high degree of consistency among the inter-meeting statements of individual committee
members
BOJ MPC
Publishes a statement after every meeting announcing the MPC decision and explaining its latest assessment of the
economic and price situation

Governor holds a press conference after every monetary policy meeting
Publishes monthly economic assessments after the MPC meets (day after in Japanese, two days after in English)
Publishes semi-annual (Oct and Apr) economic and inflation outlooks, with the October outlook including forecasts over a
longer horizon
Includes interim review of the growth and inflation outlook in the January (revision of Oct report) and July (revision of Apr
Haruhiko Kuro da, Go verno r
B ank o f Japan
So urce: B ank o f Japan
report) policy meeting statements

Submits the Semiannual Report on Currency and Monetary Control to the Diet (in Jun and Dec) and explains its policies
and answers questions at committees of both houses of the Diet

The Governor and other executives appear before committees of both houses of the Diet when requested to answer
questions regarding the conduct of the Bank's policies and operations
BOE MPC
Publishes the MPC decision after each meeting, but normally provides an explanation only when interest rates are
changed or when its decision was largely unexpected

Releases recorded votes (dissents are somewhat frequent)
Publishes a quarterly Inflation Report, which sets out the detailed economic analysis that underlies the MPC's decisions
and the BOE's assessments for inflation over the following two years, accompanied by an hour-long press conference
Publishes a Quarterly Bulletin, which comments on market developments and monetary policy operations
M ark Carney, Go verno r
B ank o f England
So urce: B ank o f England
Provides an annual report and testifies before Parliament

Generally pursues an individualistic inter-meeting communication strategy given that each member is individually
accountable
Top of Mind
Issue 18
El
Can words really equal deeds?

Robin Brooks of the GS Markets/Economics
teams finds that the jury is still out on whether
words can be as credible as deeds
Federal Reserve Chairman Ben Bernanke argued in July 2013 that a
reduction in asset purchases (tapering) could be offset via forward
guidance, so that the overall level of accommodation, and in turn,
stimulus to the economy, would remain unchanged. But for much
of the rest of the summer, US interest rates moved higher. This
was not the first time markets reacted in the opposite direction of
that intended by central banks attempting to stimulate the
economy through words. As major central banks increasingly
adopt forward guidance approaches to monetary policy, this
unexpected behavior raises the key question: can words really
equal deeds? A look at the recent US and Canadian experiences
suggests (at best) the jury is still out.
The (US) background
The Fed has been experimenting with different forms of forward
guidance for some time, all with the aim of convincing the market
of future Fed behavior in order to boost spending and investment
today. In the December 16, 2008 post-meeting statement, the Fed
said that the funds rate target would be cut to its effective lower
bound and was expected to be kept at this level for some time.
On March 18, 2009 this was strengthened to say that conditions
were likely to warrant a low funds rate for an extended period. In
2011 the Fed started experimenting with calendar guidance,
which committed to low rates over a specified period of time; the
horizon of this period was then extended twice. On December 12,
2012, the Fed shifted to using thresholds, noting that the current
exceptionally low level of interest rates would be appropriate as
long as the unemployment rate remains above 6.5%, inflation
remains below 2.5%, and longer-term inflation expectations remain
well anchored.
Word choice matters, at least sometimes
Have words worked? Intuitively, if forward guidance is credible,
US interest rates (especially in the front end of the interest rate
curve, which the Fed should influence the most) should not be
responsive to data surprises because the Fed has committed to a
certain rate path. Using this measure, calendar guidance
largely worked; front-end interest rates showed almost no
sensitivity to data surprises during the period of calendar
guidance.
But the news is not as good for threshold guidance. The
responsiveness of front-end and especially longer-dated rates
to data surprises rose sharply with the switch to thresholds.
Some of this may have been intentional - low rate volatility under
calendar guidance may have been seen by the Fed as working too
well, making the market too complacent to cyclical conditions and
the possibility of rate hikes, which could give rise to financial
imbalances. But the extent to which it happened and the fact that
the sensitivity to data rose back to pre-crisis levels may ultimately
have played a role in the Feds surprise decision not to taper, which
abruptly sent rates lower across the curve. In the end, deeds
were stronger than words, and forward guidance at least for
now is back to the drawing board.
Thresholds on, data sensitivity up

Sensitivity of changes in 3-year yield 2-years forward to positive US
MAP surprises, bps (higher value = higher sensitivity)
1.0
December 12, 2012

threshold guidance
Data sensitivity above the 2-year tenor fell sharply with
the Feds introduction of calendar guidance (Aug. 9, 2011
and Jan. 25, 2012) but then has been rising sharply
above what is normal with the shift to thresholds on
Dec. 12, 2012
0.8
0.6
0.4
0.2
August 9, 2011
calendar guidance
January 25, 2012
calendar guidance
0.0
00
01
02
03
04
05
06
07
08
09
10
11
12
13
The Canadian Experience

The Bank of Canada (BOC) experimented with forward guidance in
the aftermath of the global financial crisis. On April 21, 2009, the
BOC cut its policy rate to what it considers the effective lower
bound (25 bps), using up its conventional monetary policy tools. In
conjunction with that, it provided calendar guidance, committing
to keep rates at their low level until the end of the second quarter
of 2010, conditional on the inflation outlook. This language was
kept until March 2010, with the BOC raising its policy rate to 0.5%
in June of that year.
The yield curve for Canadian rates flattened somewhat on the
announcement, as uncertainty over the direction of future
monetary policy lessened. However, better-than-expected data
in the United States in June of 2009 prompted Canadian
interest rates to rise, as markets started looking to the escape
clause of the BOCs conditional commitment. In this case, it
seems words (no matter what the choice) were not enough.
Forward guidance: Derailed by data

%
2.0
CAD 6-12 Month OIS
1.8
CAD 3-6 Month OIS
1.6
1.4
1.2
Better-than-consensus
NFP report (Jun. 5)
Forward
guidance
introduced
1.0
0.8
0.6
0.4
0.2
0.0
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: Bloomberg.
Deeds over words

But for the US and Canadian experiences the counterfactual is
what matters. While in absolute terms interest rates moved higher
seemingly more driven by data than by words they may still
have been lower than without forward guidance. As such, the jury
is still out on how well forward guidance works. What is clear,
though, is that markets prefer deeds to words.
Robin Brooks, Senior Markets Economist

Email:
Tel:
Robin.Brooks@gs.com
(212) 902-8763
10
Top of Mind
Issue 18
El
Snapshot of our views

Implications of central bank communication
FX
Thomas Stolper
& Team
Rates
Francesco
Garzarelli
& Team
Credit
Charlie
Himmelberg
& Team
Equity
David Kostin
(US)
Kathy Matsui
(Japan)
Tim Moe
(Asia ex-Japan)
Peter Oppenheimer
(Europe)
Helen Zhu
(China)
& Teams
Commodity
Jeff Currie
& Team
Unconventional monetary policies need to be considered as extensions of traditional monetary policy. In that
sense, we would expect a dovish surprise to lead to currency depreciation and vice versa.
The problem with non-traditional policies is that they are not as easily comparable across countries as traditional
policy rates, generating substantial uncertainty. Market participants have long looked at longer maturity interest
rates to compare cross-country differences in non-conventional policies. But these relationships also change.
Calendar guidance introduces less volatility into bond yields than threshold guidance, for example.
Often it appears that gauging the distance from the stated policy target gives the best indication of central bank
stance. Currencies are likely to weaken when their central banks undershoot their individual target by a
larger margin than others.
Although forward guidance has evolved significantly since its introduction by the Fed around 2008, behind it
always laid an attempt to keep expectations of short term rates anchored around zero for a sufficient period of
time into the future.
During its first implementation in the form of calendar guidance, rate expectations became increasingly
anchored to their lower bound, to the point that long-term rates were unresponsive to macro developments and
term premium was eroded across the curve given the low volatility.
The implementation of threshold guidance has proven to be more challenging, in particular as it is seen by the
market as intrinsically intertwined with QE. Proof of this was the sharp rates sell-off during the summer driven
by the expectation of an earlier policy rate hike based on the assumption that the FOMC was going to taper in
September and the rally once the decision was delayed.
More recently, economic data have been mixed and markets have pushed out expectations for the first hike,
with implied volatility moving down to levels last seen around Bernankes testimony before Congress in May.
We believe that markets will not unwind the term premium now built into the yield curve and that 10-yr
government yields will smoothly drift higher towards our year-end forecasts of 2.75% for US Treasuries
and 2% for German Bunds. We forecast a further sell-off in 2014, as stronger expected growth pushes the
economy towards the Feds thresholds, influencing expectations of rate hikes.
We think that forward guidance is a more effective stimulus to credit risk appetite and credit creation
than QE.
But tapering is not tightening if it is accompanied by improvements in forward guidance.
Based on our conversations with investors, we think that the market is giving this point too little weight, paying
too much attention to rates risk and QE tapering, and not enough attention to the likelihood of more dovish
tailwinds from forward guidance.
We are therefore more bullish than the market on headline risks from the Fed over the next few quarters.
More generally, we think credit remains fairly valued. Credit quality remains strong, and the above arguments
plus the prospect of better growth means that the outlook for risk-taking remains favorable.
Quantitative easing (QE) has supported global equity markets in recent years, and everything else equal the
potential tapering of asset purchases is likely to be a headwind across stock markets. However, DM equities
should still be able to perform in an environment where policy is tightened as a response to a better DM growth
outlook, at least when measured over slightly longer horizons.
Equity investors are concerned that forward guidance will be an imperfect substitute for QE, though
ultimately the fundamental linkage of these policies to the equity market is through interest rates, which may be
anchored by forward guidance. Our US Economists believe forward guidance is a more effective tool for driving
growth and keeping rates low.
In the US we have found Fed commentary to be as impactful to equity returns as changes in policy rates. Our
outlook for continued easy monetary policy via low rates and forward guidance supports pro-cyclical areas of the
market such as growth, weak balance sheets and low return on capital. Communication that implies tightening
could have the opposite effect over shorter time horizons.
Looking across the global equity landscape, EMs have generally responded more negatively to a potential
tightening of US policy, especially those with significant current account deficits. On the other hand, the
normalization of unconventional policy in the United States is likely contingent upon an economic growth
recovery, which in turn would bode positively for global equity markets.
The impact of central bank easing on commodity markets has likely been limited; it is the pace of economic
activity and not forward expectations of such activity that drive physical commodity markets.
The exception is gold, as gold and US real interest typically move with a strong inverse correlation. Thus, Fed
easing has been broadly supportive of gold prices.
But the pass through of future easing on rates and ultimately gold prices is likely shifting; as threshold forward
guidance is inherently data dependent, the correlation between gold and economic activity will likely return to its
pre-QE higher level. Under our economic forecast for above trend growth in 2014, we forecast further declines in
gold prices next year.
Over the long term, the expansion of the Fed balance sheet through QE could spur inflationary pressures,
lending support to gold prices. But the substitution of QE for forward guidance may limit this potential upside.
11
Top of Mind
Issue 18
El
Efficacy of QE versus FG
Jari Stehn of our US economics team
addresses the shifting preference towards
forward guidance (FG) from asset purchases
(QE), but the difficulty is in the disentangling
The Fed has used both asset purchases (QE) and forward
guidance extensively since reaching the zero bound for the federal
funds rate in late 2008. Initially, the FOMC viewed QE as a highly
effective tool in easing financial conditions and supporting the
economy. In 2011, for example, Chairman Bernanke argued that a
wide range of market indicators supports the view that the Federal
Reserve's securities purchases have been effective at easing
financial conditions. Over the last couple of years, however, it
appears that the committees view on the relative reliability of its
two unconventional tools has shifted. In 2012, for example,
Bernanke stressed in his Jackson Hole speech that both the
benefits and costs of nontraditional monetary policies are
uncertain. This September, Bernanke stated that forward
guidance is actually the stronger, more reliable tool.
Bernanke speak
We agree
Our own research is consistent with the view that forward
guidance is a more powerful and reliable tool than asset purchases.
Specifically, our results suggest that a given change in longterm Treasury yields is about twice as effective in easing
broader financial conditions when it comes through forward
guidance as when it comes through asset purchases.
Moreover, we found that the accuracy of these estimates is
notably higher for the effects of forward guidance than QE.
Forward guidance twice as effective

Days since policy action (horiz. axis);basis points (vert. axis)
70
Response of financial conditions

to 25bp easing in 10yr treasury yield
60
Forward Guidance
QE
50
40
30
20
10
Bernanke, February 3, 2011:
"A wide range of market indicators supports the view that the Federal
Reserve's securities purchases have been effective at easing financial
conditions"
Bernanke, August 31, 2012:
"...both the benefits and costs
of nontraditional monetary
policies are uncertain"
2012
2013
Source: Federal Reserve Board.
From QE to FG
We see two main reasons why the committees thinking might
have evolved toward favoring forward guidance. First, it appears
natural for the efficacy and costs of the two policies to change
over time. Bernanke said explicitly in 2012 that the costs and
benefits of unconventional policies will also vary over time,
depending on factors such as the state of the economy and
financial markets and the extent of prior Federal Reserve asset
purchases. A larger balance sheet, for example, would be
expected to make the effects of additional QE more uncertain.
Likewise, the effectiveness of using additional forward guidance
would be expected to depend on how far market pricing is from
the committees view on the path of the funds rate.
Second, a number of academic studiesincluding work
conducted at the Fedsuggest that the efficacy of QE has
fallen relative to forward guidance. Most notably, Michael
Woodfords presentation at last years Jackson Hole conference
argued forcefully that forward guidance is a more powerful tool
than asset purchases. In addition, more recent studies of the
magnitude of QEs impact have produced estimates considerably
different from earlier studies, likely increasing Fed officials
uncertainty.
9 10 11 12 13 14 15 16 17 18 19 20
Days Since Policy Action
Bernanke, September 18, 2013:

"We have asset purchases, and we
have rate policy and guidance about
rates. It's our view that the latter, the
rate policy, is actually the stronger,
more reliable tool."
2011
These considerations were likely one reason for the committees

taper talk this summer. In particular, Chairman Bernanke argued
that Fed communication was primarily about adjusting the mix of
instruments away from QE towards forward guidance.
Difficult disentangling of QE and FG
The subsequent sharp tightening of financial conditions, however,
suggests that it is difficult to cleanly separate the effects of QE and
forward guidance in practice. In particular, the sharp sell-off
suggests that the pace of QE can act as a signaling device for the
committees intentions for future policy and therefore affect the
credibility of its forward guidance. So, when the committee raised
the possibility of tapering, the market sold off sharply because
investors pulled forward their expectations for the date of the first
funds rate hike.
This interaction between QE and forward guidance supports
our expectation that the FOMC will not want to taper its asset
purchases until the recovery has gained momentum. Although
the uncertainty is considerable, we currently expect the committee
to taper at the March 2014 meeting under our economic forecast
and provided that the next round of fiscal deadlines will prove less
disruptive than the most recent set. If this assumption proves
wrong, and especially if there is another lengthy debt ceiling fight
that lasts until close to the March FOMC meeting, the tapering
decision could be delayed even longer.
Jari Stehn, Senior US Economist

Email:
Tel:
Jari.Stehn@gs.com
212-357-6224
12
Top of Mind
Issue 18
El
Lessons from forward guidance pioneers

Lasse Holboell Nielsen of the GS European
economics team discusses lessons the ECB
can learn from the Scandinavian forward
guidance pioneers
Forward guidance is not a policy reserved for only extreme
situations. Indeed, well ahead of the global financial crisis and
before the zero lower bound of policy rates motivated some
central banks to explore the role of communication tools to achieve
further easing, Norways Norges Bank introduced a form of
forward guidance in 2005, while Swedens Riksbank followed soon
after in 2007.
This is a crucial similarity. And with a shared fundamental

underpinning of forward guidance, the Scandinavian experience
may shed light on whether a more explicit form of forward
guidance by the ECB, while maintaining full discretion, might help
the ECB more effectively influence Euro area money market rates.
Gains from transparency despite discretion
A look at how past shifts in the Riksbanks published policy
rate path have impacted market pricing suggests that changes
to the policy rate path can be just as important to shaping
forward market pricing as changes to actual policy rates.
Because the form of communication at the Riksbank is so explicit,
this experience provides a likely upper bound to what can be
achieved (e.g., by the ECB) with a fully transparent form of forward
guidance that still allows for full discretion.
Explicit but conservative

The Scandinavian central banks form of forward guidance is
among the most explicit in nature: both Norges Bank and the
Riksbank publish a policy rate path several times a year detailing
the level of the policy rate expected by the (majority) of the
Executive Board of the central bank over their forecast horizon
(around three years). In addition, the Scandinavian central banks
publish a range of economic forecasts, such as growth, inflation,
the output gap and the unemployment rate.
Although the form of forward guidance may be one of the most
explicit currently in place, the nature is more conservative: the
policy rate path is a conditional estimate of future policy rates based on the economy and market conditions not a commitment.
With no intention of attempting to tie their hands in the way that
Fed-style forward guidance aims to do by promising to keep rates
lower for longer than would normally be the case, Norges Bank
and the Riksbank maintain full discretion at all times. Forward
guidance in Scandinavia is therefore a pure communication tool
rather than an innovation in monetary policy strategy.
Shaping expectationsRiksbank style

%
6
Scandinavian monetary policy forward guidance is a

forecast, not a commitment, which has been important
given huge deviations in the past of actual policy rates
versus forecasted paths...but analysis shows that such
policy rate paths still affect market pricing.
Expected policy rate paths
Actual policy rate
%
7
Expected policy rate paths
5
Actual policy rate
4
04
05
06
07
08
09
10
11
12
13
14
15
16
Source: Norges Bank, Goldman Sachs Global Investment Research.
While we do not expect the ECB to adopt much more explicit

forward guidance, let alone to actually publish a policy rate path any
time soon, the Riksbank experience suggests that the ECBs
impact on market rates may be enhanced by increasing the
information available to the market regarding the ECBs view
of future likely policy developments. This could take the form of
increasing the length of the ECBs forecast horizon (currently only
between 1 to 2 years) or providing a greater account of the
Governing Councils deliberations.
DID YOU KNOW?
and Norges Bank style
05
06
07
08
09
10
11
12
13
14
15
16
Source: Riksbank, Goldman Sachs Global Investment Research.
Relevant for the ECB?

Scandinavian central banks lengthy experience with forward
guidance may be more relevant for the ECBs nascent forward
guidance than what one might immediately think. While the
ECBs style of forward guidance is rather vague, stating only that
policy rates will remain at current or lower levels for an extended
period of time, compared to the Scandinavian central banks
detailed policy rate paths, both the ECB and Norges Bank/the
Riksbank maintain full discretion of their policy rates at all times.
As recently as two decades ago, most central banks actively

avoided communicating about monetary policy. According to
Janet Yellen, the current Vice Chair of the Federal Reserve who
was recently nominated to succeed Chairman Bernanke:
Montagu Norman, governor of the Bank of England in the
early 20th century, reputedly lived by the motto never explain,
never excuse. The conventional wisdom among central
bankers was that transparency was of little benefit for
monetary policy and, in some cases, could cause problems that
would make policy less effective.
Source: Janet Yellen, Speech: Communication in Monetary Policy,
April 4, 2013.
Lasse Holboell Nielsen, Senior European Economist

Email:
Tel:
LasseHolboell.Nielsen@gs.com
+44(20)7774-5205
Goldman Sachs International
13
Top of Mind
Issue 18
El
Central bank communication in pics

A special thanks to our US, Europe and Japan economics teams and our commodities team for most of these pics.
Fed speaks, market listens
Words, words, words
Average Absolute change in 10yr Yield around Fed Events (2001-12),

bp
GS Fed Speak Tracker* vs. actual policy changes
100
80
Policy Change (left)
60
Fed Speak Tracker (right)
Tightening
40
20
0
Easing
-20
-40
-60
-80
0
FOMC
Statement
Minutes
Chairman
Speech /
Testimony
FRBNY
President
Speech
Vice Chair
Speech
Governor
Speech
Other
President
Speech
-100
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Source: Bloomberg, Goldman Sachs Global Investment Research.
* GS proprietary indicator that aims to capture the predictive content of Fed

communication for the policy decision at the subsequent meeting.
Forward guidance: Top of Mind!
Transparency pioneers (Inflation targeters*)
Search interest, 100 = highest point of interest
Date of inflation target* adoption
100
BOE issued
outcomebased
guidance
90
ECB issued
"extended
period"
guidance
80
70
Fed issued
outcomebased
guidance
60
Fed issued
"mid-2015"
guidance
50
40
30
20
Fed issued
"2014"
guidance
Fed issued
"extended
period"
guidance
Fed issued
"for some
time"
guidance
Fed issued
"mid-2013"
guidance
10
Year
Country
1990
New Zealand, Chile
1991
Canada
1992
Israel, United Kingdom
1993
Sweden, Finland, Australia
1995
Spain
1998
Czech Republic, Korea, Poland
1999
Mexico, Brazil, Colombia
2000
Switzerland, South Africa, Thailand
2001
Hungary, Iceland, Norway
2002
Peru, Philippines
2013
Japan
* In practice, countries that adopted inflation targeting in the 1990s at the

same time significantly increased the amount of information about
monetary policy regularly released to the public.
Source: Google Trends, Goldman Sachs Global Investment Research.
Source: Federal Reserve Transparency and Financial Market Forecasts of ShortTerm Interest Rates, Swanson, February 9, 2004; Inflation Targeting: A New
Framework for Monetary Policy? Bernanke, Mishkin, January 1997.
Gold speaking the Feds language
Questioning credibility
Gold prices, $/oz (lhs); US 10-yr TIPs yield, % (rhs)
Japanese breakeven inflation reflected in inflation-indexed JGBs, %

-0.90
1,800
2.5
Growth
strategy
-0.70
1,700
-0.50
1,600
-0.30
BOJ
introduces 2%
inflation target
1.5
September FOMC
1,500
-0.10
0.10
1.0
1,400
Final
decision
on VAT
hike
Apr 4th
unprecedented
easing
Three-party
agreement on
raising the
consumption tax
2.0
Abe elected
LDP leader
Noda Cabinet
resolution on
legislation for
raising the
consumption tax
0.30
0.5
1,300
0.50
0.70
1,200
0.0
0.90
1,100
Aug-12
Oct-12
Dec-12
Gold price
Feb-13
Apr-13
Jun-13
Aug-13
US 10 year TIPS yield (right axis, inverted)

Oct-13
-0.5
Jan-12
Apr-12
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
Source: Bloomberg.
14
-0.4
0.6
7.6
2.6
1.9
EURO AREA
GERMANY
CHINA
BRAZIL
JAPAN
1.9
2.4
7.6
0.5
0.0
1.6
2.8
1.8
2.3
7.7
2.0
0.9
2.8
3.6
1.7
2.4
7.4
1.7
0.9
2.6
3.5
2014
GS
Cons
FX
1.32
6.12
2.32
6600
1.27
6.07
2.43
107
6200
12-mth
GS
Cons
107
$/JPY
2.40
$/BRL
6.15
$/CNY
1.40
EUR/$
1.27
EUR/$
1.40
1.27
EUR/$
1.40
12-mth
GS
Cons
Copper ($/mt)
101
3-mth
GS
Cons
98
$/JPY
2.25
$/BRL
6.16
$/CNY
1.38
EUR/$
1.32
EUR/$
1.38
1.32
EUR/$
1.38
3-mth
GS
Cons
HSCEI
1300
3-mth
GS
Cons
HSCEI
TOPIX
1400
1110
12-mth
GS
Cons
BOVESPA
11000
3250
DAX
3200
Eurostoxx 50
1845
SP500
1850
Gold ($/toz)
TOPIX
1250
BOVESPA
3010
DAX
2950
Eurostoxx 50
1715
SP500
1750
12-mth
GS
Cons
Equity
3-mth
GS
Cons
4.25
1.00
2.00
2.75
1.25
2.50
3.25
4.25
12-mth
GS
Cons
Corn ($/bu)
0.10
10.25
6.25
0.50
0.13
3-mth
GS
Cons
0.10
10.00
6.00
0.50
0.13
10-yr
2013
2014
Rates (% eop)
Policy
2013
2014
Note: Recent revisions marked in red; GDP consensus is Consensus Economics, all other consensus is Reuters, commodity 12-mo consensus is Reuters for 2014 average.
105
105
110
108
12-mth
GS
Cons
3-mth
GS
Cons
Brent crude oil ($/bbl)
1.6
US
Commodities
2.8
Global
2013
GS
Cons
GDP Growth (% yoy)
Revision Notes
Without much in terms of near-term catalysts for a weaker

Yen, the risk is that range-trading in $/JPY will persist; we
therefore revised our $/JPY forecasts slightly lower on
October 10.
On October 10, we revised our $/BRL forecast towards a

stronger real to reflect a generally more constructive global
backdrop and EM FX trading environment, but the weak
macro picture and the authorities preference for a
competitive currency should limit the upside. We also
raised our Selic rate forecasts given the stickiness of
inflation.
Revision Notes
Top of Mind
Issue 18
El
Snapshot of our key forecasts
15
Top of Mind
Issue 18
El
Glossary of GS proprietary indices

Current Activity Indicator (CAI)
Measures the growth signal in the major high-frequency activity indicators for the economy. Gross Domestic Product (GDP) is a
useful but imperfect guide to current activity. In most countries, GDP is only available quarterly, is released with a substantial
delay, and initial estimates are often heavily revised. GDP also ignores important measures of real activity, such as employment
and the purchasing managers indexes (PMIs). All of these problems reduce the effectiveness of GDP for investment and policy
decisions. Our CAIs are alternative summary measures of economic activity that attempt to overcome some of these drawbacks.
We currently calculate CAIs for the following countries: USA, Euro area, UK, Norway, Sweden, China, Japan, Hong Kong, India,
Indonesia, Malaysia, Philippines, Singapore, South Korea, Taiwan, Thailand, Australia and New Zealand.
Financial Conditions Index (FCI)

Financial conditions are important because shifts in monetary policy do not tell the whole story. Our FCIs attempt to measure the
direct and indirect effects of monetary policy on economic activity. We feel they provide a better gauge of the overall financial
climate because they include variables that directly affect spending on domestically produced goods and services. The index
includes four variables: real 3-month interest rates, real long-term interest rates, real trade-weighted value of the exchange rate
and equity market capitalization to GDP.
Global Leading Indicator (GLI)

Our GLIs provide a more timely reading on the state of the global industrial cycle than the existing alternatives, and in a way that
is largely independent of market variables. Global cyclical swings are important to a huge range of asset classes; as a result, we
have come to rely on this consistent leading measure of the global cycle. Over the past few years, our GLI has provided early
signals on turning points in the global cycle on a number of occasions and has helped confirm or deny the direction in which
markets were heading. Our GLI currently includes the following components: Consumer Confidence aggregate, Japan IP
inventory/sales ratio, Korea exports, S&P GS Industrial Metals Index, US Initial jobless claims, Belgian and Netherlands
manufacturing surveys, Global PMI, GS Australian and Canadian dollar trade weighted index aggregate, Global new orders less
inventories, Baltic Dry Index.
Goldman Sachs Analyst Index (GSAI)

Our US GSAI is based on a monthly survey of Goldman Sachs equity analysts to obtain their assessments of business conditions
in the industries they follow. The results provide timely bottom-up information about US economic activity to supplement and
cross-check our analysis of top-down data. Based on their responses, we create a diffusion index for economic activity
comparable to the ISMs indexes for activity in the manufacturing and nonmanufacturing sectors.
Macro-data Assessment Platform (MAP)

Our MAP scores facilitate rapid interpretation of new data releases. In essence, MAP combines into one simple measure the
importance of a specific data release (i.e., its historical correlation with GDP) and the degree of surprise relative to the consensus
forecast. We put a sign on the degree of surprise, so that an underperformance will be characterized with a negative number and
an outperformance with a positive number. We rank each of these two components on a scale from 0 to 5, and the MAP score
will be the product of the two, i.e., from 25 to +25. The idea is that when data are released, the assessment we make will
include a MAP score of, for example, +20 (5;+4)which would indicate that the data has a very high correlation to GDP (the 5)
and that it came out well above consensus expectations (the +4)for a total MAP value of +20. We currently employ MAP for
US, EMEA and Asia data releases.
16
Top of Mind
Issue 18
El
Disclosure Appendix
Reg AC
We, Allison Nathan, Robin Brooks, Huw Pill, Kris Dawsey, Lasse Holboell Nielsen and Jari Stehn hereby certify that all of the views
expressed in this report accurately reflect our personal views, which have not been influenced by considerations of the firm's business or
client relationships.
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Economics, Commodities and Strategy Research

Interview with Michael Woodford

The taper head-fake and whats next

Can words really equal deeds?

Lessons from forward guidance pioneers

The issues raised by recent

Its a mistake to view asset

[In terms of implications for

Allison Nathan | allison.nathan@gs.com | +1 (212) 357-7504 | Goldman, Sachs & Co.

Goldman Sachs Global Investment Research

Macro news and views

Latest GS proprietary datapoints/major changes in views

Latest GS proprietary datapoints/major changes in views

The cumulative weakness in the labor market over the last

We revised our $/JPY forecasts slightly lower on October 10

We still expect growth to pick up from 1.6% in 2013E to 2.9%

Datapoints/trends were focused on

The potential for more disruption around fiscal deadlines: (1)

Datapoints/trends were focused on

US manufacturing on the rise

Japanese non-energy prices (finally) on the rise

US ISM manufacturing index

Core-core CPI (excludes fresh foods and energy), yoy %chg

Source: ISM, Goldman Sachs Global Investment Research.

Euro Area (EA)

Emerging Markets (EM)

Latest GS proprietary datapoints/major changes in views

Latest GS proprietary datapoints/major changes in views

We now expect the ECB to offer a longer-maturity LTRO, which

China growth tracking around 9% as measured by our Current

Datapoints/trends were focused on

Datapoints/trends were focused on

Rising concerns about another liquidity squeeze in China.

The euro has appreciated around 1% since the ECBs October

Continued declines in Brazilian industrial sector confidence to

Spain (finally) growing again

Inflation deviation (Mexico vs. Brazil)

% of CPI above inflation-targeting-midpoint, 3mma

Source: Haver Analytics, Goldman Sachs Global Investment Research.

The use of explicit forward guidance is one of these tools, which

We then provide our take on these questions. Our chief European

Jari Stehn of our US economics team then looks at the evolution of

We interview Michael Woodford, a professor at Columbia

Finally, Robin Brooks of our global markets team looks at market

Allison Nathan, Editor

The evolution of central bank communication/transparency

Orange = Notable innovators/ others

Source: Goldman Sachs Global Investment Research.

Interview with Michael Woodford

Michael Woodford: The most obvious danger, which has likely

the possibility of making a commitment that extends far enough

Michael Woodford: It certainly seemed to me that during the

The taper head-fake and whats next

What not tapering looked like

There are at least a couple of potential explanations. First,

upcoming transition in Fed leadership was also mentioned. On net,

DID YOU KNOW?

Kris Dawsey, US Economist

Goldman, Sachs & Co.

Forward guidance explained

Federal Funds Rate

Headline PCE Inflation

% chg, year ago