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I like the analogy.

Nothing new here, but airing my understanding - It seems to me however, that by borrowing a decision from the next FAD (Period+1 or P1), the CB must give up data dependence in P1. Interest Rate forward guidance for P1 removes the option to commit to inflation targeting in the decision at P1. Put in the extreme, to fulfil its promise for P1 and keep credibility that it will use instruments as promised, the CB must give up (if only a little bit) its promise to of a data dependent use of instruments for inflation targeting.

Now that's way over extreme, but gets at why forward guidance is *unhelpful* during normal times. In normal times, the CB should promise to be flexible!

Sometimes however, it might make sense to pick rate promises over inflation targeting promises. A) if CB is confident at P0 that they would pick rate R1 at P1 anyway, it makes sense to announce that; B) if the CB believes that the representative agent's expectation of the CB's data dependent behaviour doesn't match the CB's expectation of its own behaviour then it makes sense to try to pre-announce that behaviour (with the assumption that the even if circumstances change, they can make up for it in P2).

Sqeeky: Glad you liked the analogy. I was hoping it would work.

Suppose that demand this period depends both on this period's r and on expectations of next period's r. Which is a reasonable assumption. In one parallel world the central bank always sets this period's r. In the second parallel world the central bank always sets next period's r. It is not obvious to me which of the two central banks would be able to keep inflation closer to target. And it is not obvious to me what the answer to that question would depend on. The second central bank is more reliant on its credibility though. [edit: see my next post on that question.]

Quite right: the BoC has standing "forward guidance" that inflation rates will be 2%. Forward guidance under the name applies to interest rates.

But what can this mean? That the Bank is offering guidance on both inflation and interest rates simultaneously? I think not; it can only mean that the guidance on interest rates will supersede that on inflation rates during the forward guidance period. Can this commitment be unconditional? Again, I think not; were realized inflation rates to reach, say, 30% the commitment would surely be broken.

So "forward guidance" on interest rates really means something like "during the next x months we are temporarily willing to tolerate inflation rates a little higher than 2% before we raise our policy interest rates. But we won't tell you how much higher. 3%? 4%? We'll let you guess for yourself."

My opinion is the bank would be better off simply modifying its forward guidance on inflation directly; something like "we would like to see inflation hit 3% for 6 months or 4% for 3 months before we return to a 2% target.

The reason they don't do this is likely political; deliberately targeting higher inflation is unpopular. Again, in my opinion this is misguided; the reason is that successful policy will require the realization of higher inflation rates in any case.

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