Nobel winner Woodford points to forward guidance, the practice Fed Chair Warsh scrapped

Woodford's own example of guidance at work comes from a crisis in which the policy rate could not be cut any further ^[3]. "Even after the short-term nominal interest rate controlled by central banks had already fallen to zero, unemployment remained very high and aggregate demand was far short of what was needed," he said of 2008 ^[3]. The report does not say which parts of the Fed's signaling Warsh dropped, when he dropped them, or where the policy rate sits now. In our view the strongest case for guidance is the one Woodford described: a rate at zero, where belief about the future path is the only lever left. A central bank with room to move the rate has others.

His wider claim concerns what people understand. "One of the main themes of my work is that the authorities should not try to control the economy regardless of how people understand it," Woodford said ^[9]. He added: "My research emphasized that the understanding of market participants, and their expectations about future policy, matter a great deal for the actual effects of policy." ^[4] On that logic, markets have to interpret a withdrawn signal too.

We think the first cost to show up is wider disagreement among forecasts of the rate path. With no official reference, each desk prices its own path, and the paths differ. The counter-thesis is that data-dependence is also a signal, that traders learn it quickly, and that the spread does not widen. A third outcome is that the Fed restores some advance signaling if the spread becomes a nuisance to it. Measured dispersion of rate-path forecasts around the next few Fed meetings would separate the first two; if it is no wider than before Warsh's change ^[12], we are wrong.