## insea2026008 ## Source details **Canonical URL:** [insea2026008](https://www.imf.org/-/media/files/publications/imf-notes/2026/english/insea2026008.pdf) ## Other formats - [Markdown version](/-/media/files/publications/imf-notes/2026/english/insea2026008.pdf.md) - [Structured JSON version](/-/media/files/publications/imf-notes/2026/english/insea2026008.pdf.json) --- ### Summary of central themes - Forward guidance is defined narrowly as communication about the future path of the policy rate (Woodford 2007; Svensson 2014), while recognizing broader uses of the term to include reaction-function communication and publication of forecasts. - Three distinct concepts are distinguished: - explicit commitments about the future path of the policy rate (rate path commitments); - communication about the monetary authority’s reaction function (which data and judgments matter); - publication of the economic outlook and forecasts (including staff or policymaker rate-path projections). - Utility and risks of forward guidance are state dependent: commitments are especially useful at the effective lower bound (ELB) but can be costly during large supply shocks (postpandemic inflation experience). - Recommendation: organize communications around a robust policy framework and state dependence rather than a single unconditional future rate path. ### Key findings about forward guidance usage and limits - At the ELB, credible commitments to keep rates “lower for longer” can reduce expected short-term rates and term premiums, easing financial conditions (Eggertsson and Woodford 2003; Woodford 2003). - When inflation rises unexpectedly (postpandemic), earlier commitments premised on low inflation can: - delay necessary policy adjustment; - confuse the public; or - create the perception that policymakers are tied to outdated assessments. - Distinguish Delphic versus Odyssean guidance: - Delphic guidance: explains the central bank’s conditional assessment of the outlook and likely policy path. - Odyssean guidance: ties the central bank to a future policy that may diverge from past expectations and is more powerful at the ELB but risks conflict with price stability if conditions change. - Forward guidance interpreted as unconditional promises (rather than conditional forecasts) generates confusion and potential credibility costs. ### Policy implications and recommendations - Use explicit rate-path commitments sparingly and principally when confronting the ELB; ensure commitments are explicitly conditional and contain escape clauses. - Strengthen communication about the reaction function: - Explain which data matter (for example, inflation expectations, underlying inflation, credit conditions, real activity) and how trade-offs between inflation and output are weighed—especially under dual-mandate frameworks. - Maintain humility about model uncertainty and forecast errors; be transparent about assumptions and risks. - Publish forecasts and scenarios to reveal how the reaction function maps outlooks into policy stances, but emphasize conditionality to avoid misinterpretation as promises. - Organize public communication around policy frameworks and scenarios rather than a single unconditional path for future rates; ground messages in specific scenarios that map combinations of inflation outcomes, demand shortfalls, and indicators of financial stress to likely policy responses. - Communicate risk clearly to preserve appropriate risk-taking incentives in financial institutions: improve the “quality of volatility” (volatility driven by macro data supports price discovery; volatility driven by shifting perceptions of policy intentions is less informative and more disruptive). ### Operational guidance for central banks - Avoid unnecessary precision about future instrument paths when shocks cause rapid changes in the macroeconomic environment; emphasize state-dependence. - Preserve monetary transmission and accountability while avoiding artificially compressed market volatility or constraints on future policy. - Use conditional language and escape clauses to keep commitments subordinate to the central bank’s price stability mandate. - In normal times, prioritize making policy predictable by clarifying how the central bank would respond to the outlook, rather than committing to a particular rate path. ### Box 2 — Postpandemic Forward Rate Guidance: episode and lessons - The postpandemic inflation episode is often cited as evidence against forward guidance. - Forecasting failure may have led policymakers to underestimate inflationary pressures. - There may have been a policy failure because central banks may have reacted too slowly after the outlook changed. - Earlier commitment based forward guidance may have constrained tightening once adverse supply shocks hit. - Guidance designed for a low-inflation environment can become unsuitable when persistent shocks change conditions. - Reserve Bank of Australia’s (2022) review: forward guidance helped lower funding costs near the ELB, but time-based language was understood by the public as a promise, creating credibility costs when the policy rate rose. - New Keynesian models generate very large effects from promises about policy rates (Eggertsson and Woodford 2003). - Del Negro, and others (2023): quantitative implications of expected future short rates on activity can be implausibly large in such models. - The response of current activity to far-in-the-future interest rates may be weaker in practice than in theory—supports communication that is conditional and features data dependence. - The narrower definition of forward guidance still allows conditional communication about likely policy direction; forward guidance should be state dependent and subordinate to the mandate, while broader reaction-function communication remains essential if conditional, disciplined, and uncertainty aware. ### Reaction function and data dependence (Box 2) - “Data dependence” without a clearly conveyed reaction function can appear as unstructured policy discretion. - Effective data dependence requires explaining which data matter and how they affect the balance of risks. - Different shocks propagate via different channels: - Supply shock (e.g., rise in energy prices) can affect inflation expectations, wages, and pricing behavior; if second-round effects emerge, policy might lean against persistence despite output effects. - Demand shocks have large implications for the inflation-output trade-off. - Financial shocks affect credit conditions and risk premiums, which can change the restrictiveness of a given policy rate. - Conditional communication clarifies state-dependent behavior and how shocks, transmission channels, and risks determine policy decisions. - Reaction function communication should explain how the desired policy stance will change if the state of the world changes; it is distinct from explicit commitments. - Examples of practice: - The European Central Bank emphasizes a qualitative reaction function organized around its outlook for inflation and the perceived strength of the monetary transmission channel (Lane 2021; Lagarde 2025). - Authorities avoid explicit mechanical rules but provide frameworks (three-pillar framework) for interpreting decisions. - Three-pillar framework: - If the inflation outlook remains above target and underlying inflation persistent → framework points to maintaining or increasing restrictiveness. - If inflation decreases but underlying price or wage dynamics look firm → reasons why policy may need to remain restrictive. - If inflation is declining toward target and transmission is weighing on demand → justify a more cautious recalibration of the monetary stance. - Challenges: - Greater transparency can increase complexity under higher uncertainty (Lane 2024; Lombardelli 2025). - Technical details required for explaining the reaction function may be hard to convey to the general public. - Differing emphases by committee members can be interpreted as conflicting signals. - Uncertainty about shock nature complicates communication and policy response. - Communication guidance: - Avoid suggesting certain data will mechanically determine policy. - Focus on diagnostic questions, evidence to distinguish interpretations, and contingencies. - Emphasize policy depends on indicators and on what kind of shock those indicators reveal. ### Forecasts, scenarios, and their communication role (Box 2) - Forward-looking policy relies heavily on forecasts to anchor macro variables around the price stability objective. - Flexible inflation targeting is forecast-based: central banks consider current inflation and the view of future price paths. - Forecast targeting ties policy instruments, inflation objectives, and stabilization goals (Svensson and Woodford 2003). - Forecasts do not imply a promise; they are conditional analyses under specific assumptions. - Forecast errors are updates to evolving information, not policy reversals. - Authorities should communicate forecasts transparently, emphasize conditionality, and highlight risks around the baseline. - Policy-rate forecasts can aid communication about the reaction function; detail should match institutional capacity and include caveats about uncertainty and rapid revisions. - Scenarios complement forecasts in high-uncertainty environments: - Convey how the economy and monetary stance may evolve under different shocks. - Share views about risks and how policy may react—essential for risk-taking incentives of financial institutions. - Possible scenarios: higher-than-expected inflation, shortfalls in aggregate demand, tighter financial conditions, increases in commodity prices. - Scenarios reduce the likelihood the baseline projection is misunderstood as a commitment. - Risks of scenarios: - Too many scenarios can be overwhelming; poorly designed scenarios can be misinterpreted. - Committee members may attach different probabilities or emphasize different risks; scenarios should be tools for reasoning, not commitments. ### Box 3 — Scenarios, Uncertainty, and Communication #### Purpose of scenario-based communication - Scenarios explain how policy would respond if the economy evolves differently than the baseline. - Scenarios provide public understanding of contingencies that could lead to policy changes. - Scenario communication is especially important when uncertainty is skewed or nonlinear. - To avoid complexity, limit scenario number and explain the reaction function linking each scenario to policy. #### Risk management and inflation-targeting communication - Inflation targeting combines a clear nominal anchor with recognition of trade-offs between inflation, activity, and financial stability. - Communication should explain how inflation will return to target and why temporary deviations can be tolerated. - Risk management organizes communication around the reaction function and balance of risks. - Brainard (1967) principle: when state or transmission uncertainty is higher, gradual policy changes are reasonable. - Exception: severe financial stress can justify decisive rate easing, balance sheet interventions, or liquidity provision to address market dysfunctions. - Scenario-based communication helps avoid presenting one path as sole guidance and makes revisions understandable as disciplined updates. - Proper risk communication preserves financial institutions’ incentives; unduly compressing market volatility can fuel excessive risk-taking. #### Communication and market volatility - Transparency anchors expectations but excessive detail can impair markets’ informational role by making participants over-focus on decoding signals (Stein 2014). - Forward guidance risks compressing market volatility, encouraging risk-taking by nonbank intermediaries (Adrian and Shin 2008). - Compressed volatility can feed back into market pricing and interest rates, potentially increasing system-wide risk. - More extensive communications can reduce surprises but increase markets’ sensitivity to central bank language (Stein and Sunderam 2015). - Goal: do not eliminate volatility—macro-data-driven volatility supports price discovery; volatility driven by changing perceptions of policy intentions is less informative and more disruptive. - Communications should stabilize public understanding of the reaction function and convey relevant economic uncertainty rather than promise a single unconditional future rate path. - Conditional policy forecasts should be linked to the outlook and supported by scenarios illustrating state contingency. - Recent IMF work (Katz 2026) urges robust, adaptable approaches; forward guidance should link price stability goal, reaction function, financial risks, and instruments into a coherent narrative. - Communications should be layered: concise public messages, market-facing explanations with sufficient data, and technical material documenting models, scenarios, and assumptions. #### The risk-taking channel of monetary policy - Market-based financial intermediaries (nonbank intermediaries such as securities broker-dealers) transmit policy through balance-sheet responses to the policy rate. - Intermediaries face risk-management and regulatory constraints; balance sheet size responds directly to the policy rate, creating a risk-taking channel complementary to the intertemporal savings and investment channel. - Leverage is procyclical, amplifying booms and busts. - Lower interest rates fuel intermediary balance sheet growth; risk-taking can feed into the level of interest rates. - Adrian and Duarte (2025) formalize an asymmetry in downside risks associated with intermediary risk taking; optimal policy conditions on downside risks from the leverage cycle. - Market volatility impacts risk-taking via value-at-risk–based leverage constraints: when risk measures fall, constraints loosen and balance sheets grow. - If central bank communication compresses uncertainty around future short rates, measured financing risk of maturity transformation falls, potentially encouraging leveraged maturity transformation. - Forward guidance is not costless; financial stability considerations must be explicitly taken into account. - Optimal policy should condition on outlook for inflation and real activity and on downside risks. #### Communications during acute liquidity crises - In imminent liquidity crises threatening macroeconomic and financial stability, central banks must take forceful action and provide greater certainty about implications for interest rates and broader financial conditions. - Market dysfunction can evolve rapidly from confidence deterioration or jumps in risk premia into impaired intermediation, deleveraging, and real economic downside risks. - Historical episodes: the 1987 stock-market crash, the global financial crisis, and the 2020 “dash for cash” demonstrate liquidity support can prevent market dysfunction. - Policy implications: - Deploy liquidity facilities, asset purchases, and other interventions promptly and decisively when funding pressures or impaired intermediation threaten financial stability. - Adjust policy rate only to the extent the financial shock changes the downside outlook. - Some crises justify prompt rate cuts; other crises justify substantial liquidity support while the monetary stance remains restrictive. - Crisis communication should highlight objectives, reaction functions, and instrument assignments, but avoid explicit commitments to a policy-rate path. - Example: banking stress from March 2023 — authorities deployed liquidity facilities to bolster confidence and support intermediation while policy rates could remain restrictive if inflationary pressures persisted. - Crisis communication should emphasize mandate and separate liquidity tools from the monetary stance. #### Balance sheet policy and quantitative easing - Asset purchases are used as easing when nominal rates are constrained by the ELB; QE often works together with forward guidance. - Purchases aim to compress term premiums while guidance shapes expectations on nominal rates. - When limits to forward guidance’s efficacy exist, asset purchases can support output and inflation in a liquidity trap. - QE can improve the consolidated fiscal position by bolstering recovery, improving revenues, and lowering debt servicing costs even when central bank accounting losses materialize later. - Communications must not present fiscal effects as central-bank objectives; effects depend on macro environment, debt maturity structure, and eventual discontinuation of purchases. - Clear escape clauses are crucial; communications should underline balance sheet policy is grounded in the central bank’s mandate, appropriate market functioning, and is temporary. - Easing in crisis should be explicitly labeled temporary and aimed at restoring financial stability and the transmission mechanism. - Avoid framing communications as an unconditional commitment to keep central bank balance sheets large after the liquidity problem has passed. - Scenario analyses can help explain the asset purchase regime and clarify the temporary nature of interventions. #### Artificial Intelligence and communications - Communications operate in an environment where social media, automated news analysis, and AI tools play increasingly relevant roles. - AI tools can enhance communication consistency, clarify language, avoid unnecessary complexity, and assess whether forward-looking guidance is being interpreted as explicit commitments. - Recent IMF research has quantified central bank communications and highlighted advantages of systematic benchmarking (Silva, Moriya, and Veyrune 2025; Caselli and others 2026). - Risks: AI-based communication analysis can inadvertently strip qualitative nuance, leading market participants to search for implicit signals and miss conditioning assumptions. - A disciplined communications framework is key: stable terminologies, explicit discussions of uncertainty assessments, and frequent reminders that policies remain conditional. #### Conclusion — principles for forward guidance and IMF surveillance - Forward guidance can guide expectations but risks being understood as a commitment that constrains future policy. - Any forward guidance should be clearly conditional on the future state of the economy and serve the central bank’s price stability mandate. - Postpandemic experience supports a narrower view of forward guidance focused on rate communication and clear communication of objectives and reaction functions. - Communication should be organized around a clear framework and tailored to different audiences, especially as AI and automated interpretation tools create novel risks. - Scenarios support communication of objectives and reaction functions, specify risks around forecasts, and explain policy reactions under alternative scenarios. - In normal circumstances, cautious policy when uncertainty is elevated can avoid artificially compressing market volatility and increasing risk-taking incentives. - Under acute liquidity stress, forceful intervention may be necessary; communications should emphasize conditionality and mandate-consistent objectives. - For IMF policy advice, assess whether: - communication is consistent with the central bank mandate; - forecasts and scenarios are clearly conditional; and - information on the rate path is being interpreted as a commitment. *Source: Author. (Box 3, insea2026008 - "Scenarios, Uncertainty, and Communication")* ### Introduction ........................................................................................................... ### Introduction ### Summary of central themes - Forward guidance is defined narrowly in this Note as communication about the future path of the policy rate (Woodford 2007; Svensson 2014), while recognizing broader uses of the term to include reaction-function communication and publication of forecasts. - The Note distinguishes three related concepts that are often conflated in practice: - explicit commitments about the future path of the policy rate (rate path commitments); - communication about the monetary authority’s reaction function (which data and judgments matter); - publication of the economic outlook and forecasts (including staff or policymaker rate-path projections). - The utility and risks of forward guidance change with macroeconomic conditions: commitments are especially useful at the effective lower bound (ELB) but can be costly during large supply shocks (postpandemic inflation experience). - The Note recommends organizing communications around a robust policy framework and state dependence rather than around a single unconditional future rate path. ### Key findings about forward guidance usage and limits - At the ELB, credible commitments to keep rates “lower for longer” can reduce expected short-term rates and term premiums, easing financial conditions (Eggertsson and Woodford 2003; Woodford 2003). - When inflation rises unexpectedly (postpandemic), earlier commitments premised on low inflation can: - delay necessary policy adjustment; - confuse the public; or - create the perception that policymakers are tied to outdated assessments. - Distinguishing Delphic versus Odyssean guidance (Campbell and others 2012, 2017) is essential: - Delphic guidance: explains the central bank’s conditional assessment of the outlook and likely policy path. - Odyssean guidance: ties the central bank to a future policy that may diverge from past expectations and is more powerful at the ELB but risks conflict with price stability if conditions change. - Forward guidance interpreted as unconditional promises (rather than conditional forecasts) generates confusion and potential credibility costs. ### Policy implications and recommendations - Use explicit rate-path commitments sparingly and principally when confronting the ELB; ensure commitments are explicitly conditional and contain escape clauses. - Strengthen communication about the reaction function: - Explain which data matter (for example, inflation expectations, underlying inflation, credit conditions, real activity) and how the trade-offs between inflation and output are weighed—especially under dual-mandate frameworks. - Maintain humility about model uncertainty and forecast errors; be transparent about assumptions and risks. - Publish forecasts and scenarios to reveal how the reaction function maps outlooks into policy stances, but emphasize conditionality to avoid misinterpretation as promises. - Organize public communication around policy frameworks and scenarios rather than a single unconditional path for future rates; ground messages in specific scenarios that map combinations of inflation outcomes, demand shortfalls, and indicators of financial stress to likely policy responses. - Communicate risk clearly to preserve appropriate risk-taking incentives in financial institutions: improve the “quality of volatility” (volatility driven by macro data supports price discovery; volatility driven by shifting perceptions of policy intentions is less informative and more disruptive). ### Operational guidance for central banks - Avoid unnecessary precision about future instrument paths when shocks cause rapid changes in the macroeconomic environment; emphasize state-dependence. - Preserve monetary transmission and accountability while avoiding artificially compressed market volatility or constraints on future policy. - Use conditional language and escape clauses to keep commitments subordinate to the central bank’s price stability mandate. - In normal times, prioritize making policy predictable by clarifying how the central bank would respond to the outlook, rather than committing to a particular rate path. *Source: IMF Note — Introduction (pages 4–8), Tobias Adrian, August 2026.* ### Box 2 Postpandemic Forward Rate Guidance ### Box 2 Postpandemic Forward Rate Guidance ### Postpandemic episode and key lessons - The postpandemic inflation episode is often cited as evidence against forward guidance. - Forecasting failure may have led policymakers to underestimate inflationary pressures. - There may have been a policy failure because central banks may have reacted too slowly after the outlook changed. - Earlier commitment based forward guidance may have constrained tightening once adverse supply shocks hit. - The episode underlines that guidance designed for a low-inflation environment can become unsuitable when the shocks change in a persistent fashion. - Reserve Bank of Australia’s (2022) review found that forward guidance helped lower funding costs near the effective lower bound, but time-based language was understood by the public as a promise, creating credibility costs when the policy rate rose. - New Keynesian models generate very large effects from promises about policy rates (Eggertsson and Woodford 2003). - The quantitative implications of expected future short rates on activity can be implausibly large in such models, as argued by Del Negro, and others (2023). - The response of current activity to far-in-the-future interest rates may thus be weaker in practice than in theory—this supports communication that is conditional and features data dependence. - The narrower definition of forward guidance still allows central banks to communicate conditionally about the likely direction of policy; forward guidance—in this narrow sense—should be state dependent and subordinate to the mandate, but broader communication about reaction function remains essential as long as it is conditional, disciplined, and uncertainty aware. ### Reaction function and data dependence - “Data dependence” is often taken to mean the opposite of “forward guidance,” but data dependence without a clearly conveyed reaction function is opaque and can appear as unstructured policy discretion. - For data dependence to be effective, authorities must carefully convey which data matter and how they affect their balance of risks, helping the public understand the conditional logic linking new data to decisions. - Different types of shocks propagate through different channels and lead to different macroeconomic outcomes: - A rise in energy prices from a supply shock can directly affect inflation expectations, wages, and pricing behavior; if second-round effects emerge, monetary policy might lean against persistence despite output effects. - Demand shocks pose potentially large implications for the inflation-output trade-off. - Financial shocks affect credit conditions and risk premiums, which can alter or impair the transmission channel—making a given policy rate suddenly more restrictive. - Conditional communication aids public understanding of state-dependent behavior, clarifying how shocks, transmission channels, and risks determine policy decisions. - Reaction function communication should explain how the desired policy stance will change if the state of the world changes; it is distinct from guidance based on explicit commitments. - Examples of central bank practice: - The European Central Bank has emphasized a qualitative reaction function organized around its outlook for inflation and the perceived strength of the monetary transmission channel (Lane 2021; Lagarde 2025). - Authorities avoid an explicit mechanical rule but provide a framework for interpreting decisions, tying back to a three-pillar framework organized according to different data realizations. - The three-pillar framework: depending on indicators, - If the inflation outlook remains above target and underlying inflation persistent → framework points to maintaining or increasing restrictiveness. - If inflation decreases but underlying price or wage dynamics look firm → reasons why policy may need to remain restrictive. - If inflation is declining toward target and transmission is weighing on demand → justify a more cautious recalibration of the monetary stance. - Challenges of greater transparency and reaction-function communication: - Greater transparency can increase complexity when policy is made under higher uncertainty (Lane 2024; Lombardelli 2025). - Explaining the reaction function requires technical details (wage dynamics, financial conditions, underlying inflation, role of expectations), which may be hard to convey to the general public. - Differing emphases by committee members can be interpreted as conflicting signals unless organized around a common framework. - Uncertainty about the nature of shocks (supply constraints, shifts in inflation expectations, changes in markups, wage dynamics) complicates communication; observed indicators can be informative about outcomes but less so about the right policy response. - Communication guidance for reaction functions: - Avoid suggesting certain data will mechanically determine policy. - Focus on diagnostic questions policymakers are asking, evidence that would distinguish competing interpretations, and contingencies that would follow. - Emphasize that policy depends both on what indicators show and on what kind of shock those indicators reveal. ### Forecasts, scenarios, and their communication role - Forward-looking monetary policy relies heavily on forecasts to anchor macroeconomic variables around the price stability objective. - Flexible inflation targeting is forecast-based: central banks consider current inflation together with a view of where prices are likely to be over the horizon of interest. - Svensson and Woodford (2003) show forecast targeting ties together policy instruments, inflation objectives, and stabilization goals. - Woodford (2007) highlights forecast targeting can help reconcile rules and discretion by referencing a coherent projected path for inflation and activity. - Adrian (2018) argues that if the central bank can explain how it will adjust policy as conditions evolve to bring inflation back to target, the nominal anchor is strengthened (see also Casiraghi and Perez 2022). - Forecasts do not imply a promise; they are a conditional analysis under specific assumptions about future shocks and the path of relevant macroeconomic variables. - Forecast errors are not policy reversals but authorities’ updates to new and evolving information. - Authorities should communicate forecasts transparently, emphasizing that they are conditional and highlighting risks around the baseline. - Policy-rate forecasts can play a constructive role in communications about the underlying reaction function; their level of detail should match the capacity and institutional design of the central bank and include caveats about uncertainty and possibility of rapid revisions. - Scenarios complement forecasts, especially in high-uncertainty environments: - Scenarios convey how the economy and monetary stance may evolve under different realizations of possible shocks. - The key goal is to share views about risks going forward and how policy may react—essential for proper risk-taking incentives of financial institutions. - Possible scenarios include higher-than-expected inflation, shortfalls in aggregate demand, tighter financial conditions, and increases in commodity prices. - Scenarios make risk management more explicit and reduce the likelihood the baseline projection is misunderstood as a commitment to future policy. - Risks of scenarios: - Too many scenarios can be overwhelming; poorly designed scenarios could be misinterpreted. - Committee members may attach different probabilities or emphasize different risks; scenarios should be tools for reasoning about contingencies, not commitments or competing policy preferences. - Box 3 in the source discusses the policy case for scenarios and communication about uncertainty. *Source: Author.* ### Box 3 Scenarios, Uncertainty, and Communication ### Box 3 Scenarios, Uncertainty, and Communication ### Scenarios and the purpose of scenario-based communication - Scenarios allow central banks to explain how policy would respond if the economy evolved differently than the baseline forecast. - Scenarios provide the public with an understanding of contingencies that could lead to policy changes. - Scenario communication is especially important when uncertainty is skewed or nonlinear. - To avoid excessive complexity, limit the number of scenarios and explain the reaction function linking each scenario to policy. ### Risk Management and inflation-targeting communication - Inflation targeting combines a clear nominal anchor with recognition of trade-offs between inflation, economic activity, and financial stability. - Communication should explain how inflation will return to target and why temporary deviations can be tolerated. - Risk management organizes communication around the central bank’s underlying reaction function and the balance of risks. - Brainard (1967) principle: when the state of the economy or transmission strength is more uncertain, gradual policy changes are reasonable. - Exception: in situations of severe financial stress, uncertainty can justify decisive rate easing, balance sheet interventions, or liquidity provision to address market dysfunctions. - Scenario-based communication helps avoid presenting one path as the sole relevant guide and makes future revisions understandable as disciplined updates. - Proper communication of risks is key to preserving financial institutions’ incentives for risk-taking; unduly compressing market volatility can fuel excessive risk-taking. ### Communication and market volatility - Transparency anchors expectations but excessive detail can impair markets’ informational role by causing market participants to over-focus on decoding central bank signals. - Stein (2014): communication is a strategic interaction; overly elaborate communication can make market prices less informative, weakening an essential input for monetary policy. - Adrian and Shin (2008): forward guidance risks compressing market volatility, which can encourage risk-taking by financial institutions, especially nonbank intermediaries. - Compressed volatility can feed back into market pricing and interest rates, potentially increasing system-wide risk. - More extensive communications can reduce surprises around policy meetings but increase markets’ sensitivity to central bank language (Stein and Sunderam 2015). - The goal is not to eliminate volatility: macroeconomic-data-driven volatility supports price discovery; volatility driven by changing perceptions of policy intentions is less informative and more disruptive. - Communications should stabilize public understanding of the reaction function and convey the relevant level of economic uncertainty rather than promise a single unconditional path for future rates. - Conditional policy forecasts should be clearly linked to the outlook and supported by scenarios illustrating state contingency. - Recent IMF work (Katz 2026) urges robust, adaptable approaches clearly communicated; forward guidance should link price stability goal, reaction function, financial risks, and instruments into a coherent narrative. - Communications should be layered: concise public messages, market-facing explanations with sufficient data, and technical material documenting models, scenarios, and assumptions. ### The risk-taking channel of monetary policy - Market-based financial intermediaries (nonbank intermediaries such as securities broker-dealers) transmit monetary policy through balance-sheet responses to the policy rate. - Intermediaries face risk-management and regulatory constraints; balance sheet size responds directly to the policy rate, creating a risk-taking channel complementary to the intertemporal savings and investment channel. - Leverage is procyclical, amplifying booms and busts. - Lower interest rates fuel intermediary balance sheet growth; risk-taking can feed into the level of interest rates. - Adrian and Duarte (2025) formalize an asymmetry in downside risks associated with intermediary risk taking; optimal monetary policy conditions on downside risks from the leverage cycle. - Market volatility impacts risk-taking via value-at-risk–based leverage constraints: when risk measures fall, constraints loosen and balance sheets grow. - If central bank communication compresses uncertainty around future short rates, measured financing risk of maturity transformation falls, potentially encouraging leveraged maturity transformation. - Forward guidance is not costless; financial stability considerations must be explicitly taken into account in policy communication. - Optimal monetary policy should condition on central outlook for inflation and real activity and on downside risks. ### Communications during acute liquidity crises - In imminent liquidity crises that threaten macroeconomic and financial stability, central banks must take forceful action and provide greater certainty about implications for interest rates and broader financial conditions. - Market dysfunction can evolve rapidly from a deterioration in confidence or jumps in risk premia into impaired intermediation, deleveraging, and real economic downside risks. - Historical episodes cited: the 1987 stock-market crash, the global financial crisis, and the 2020 “dash for cash” demonstrate that liquidity support can prevent market dysfunction. - Policy implication: respond forcefully to acute liquidity crises with a clear assignment of instruments to objectives. - Deploy liquidity facilities, asset purchases, and other interventions promptly and decisively when funding pressures or impaired intermediation threaten financial stability. - Adjust policy rate only to the extent the financial shock changes the downside outlook. - Some crises justify prompt rate cuts; other crises justify substantial liquidity support while the monetary stance remains restrictive. - Crisis communication should highlight objectives, reaction functions, and instrument assignments, but avoid explicit commitments to a policy-rate path. - Example: banking stress from March 2023 — authorities deployed liquidity facilities to bolster confidence and support intermediation while policy rates could remain restrictive if inflationary pressures persisted. - Crisis communication should emphasize mandate and separate liquidity tools from the monetary stance. ### Balance sheet policy and quantitative easing - Asset purchases have been used as an easing tool when nominal rates are constrained by the effective lower bound; quantitative easing (QE) often works together with forward guidance. - Purchases aim to compress term premiums while guidance shapes expectations on nominal rates. - When limits to forward guidance’s efficacy exist, asset purchases can support output and inflation in a liquidity trap. - QE can improve the consolidated fiscal position by bolstering recovery, improving revenues, and lowering debt servicing costs even when central bank accounting losses materialize later. - Communications must not present these fiscal effects as central-bank objectives; effects depend on macro environment, debt maturity structure, and eventual discontinuation of purchases. - Clear escape clauses are crucial; communications should underline that balance sheet policy is grounded in the central bank’s mandate, appropriate market functioning, and is temporary. - Easing in crisis should be explicitly labeled temporary and aimed at restoring financial stability and the transmission mechanism. - Avoid framing communications as an unconditional commitment to keep central bank balance sheets large after the liquidity problem has passed. - Scenario analyses can help explain the asset purchase regime and strengthen credibility by clarifying temporary nature of interventions. ### Artificial Intelligence and communications - Communications operate in an environment where social media, automated news analysis, and AI tools play increasingly relevant roles. - AI tools can enhance communication consistency, clarify language, avoid unnecessary complexity, and assess whether forward-looking guidance is being interpreted as explicit commitments. - Recent IMF research has quantified central bank communications and highlighted advantages of systematic benchmarking (Silva, Moriya, and Veyrune 2025; Caselli and others 2026). - Risks: AI-based communication analysis can inadvertently strip qualitative nuance, leading market participants to search for implicit signals and miss conditioning assumptions. - A disciplined communications framework is key: stable terminologies, explicit discussions of uncertainty assessments, and frequent reminders that policies remain conditional. ### Conclusion — principles for forward guidance and IMF surveillance - Forward guidance can guide public expectations but risks being understood as a commitment that constrains future policy. - Any forward guidance should be clearly conditional on the future state of the economy and serve the central bank’s price stability mandate. - Postpandemic experience supports a narrower view of forward guidance focused on rate communication and clear communication of objectives and reaction functions. - Communication should be organized around a clear framework and tailored to different audiences, especially as AI and automated interpretation tools create novel risks. - Scenarios support communication of objectives and reaction functions, specify risks around forecasts, and explain policy reactions under alternative scenarios. - In normal circumstances, cautious policy when uncertainty is elevated can avoid artificially compressing market volatility and increasing risk-taking incentives. - Under acute liquidity stress, forceful intervention may be necessary; communications should emphasize conditionality and mandate-consistent objectives. - For IMF policy advice, assess whether: - communication is consistent with the central bank mandate; - forecasts and scenarios are clearly conditional; and - information on the rate path is being interpreted as a commitment. - These principles provide a framework for surveillance and policy dialogue. *Source: Author. (Box 3, insea2026008 - "Scenarios, Uncertainty, and Communication")* --- _Source: https://www.imf.org/-/media/files/publications/imf-notes/2026/english/insea2026008.pdf_