Federal Reserve

Make forward guidance real: Nobel-prize economist

Tracking uncertainty in economic policy

Forward guidance from the U.S. Federal Reserve has been vague and the central bank should ensure its guidance on monetary policy is real, says one Nobel prize-winning economist.

The Fed as well as the European Central Bank and Bank of England have adopted 'forward guidance' at their policy meetings to give financial markets greater clarity on the outlook for monetary policy.

While this is a good idea in theory, the reality has proved different, Lars Peter Hanson, a professor at the University of Chicago, told CNBC Asia's "Squawk Box" Wednesday.

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"Forward guidance was meant to be a clear statement from the Fed about when it would change interest rates. That was the original rational," said the economist, who was a joint winner of the 2013 Nobel Prize in economic sciences.

"It seems that the commitments have been more and more vague and been open to more and more contingencies and it's opened the door to more and more discretion. That's one way you add more uncertainty to the economic environment," he added.

University of Chicago professor Lars Peter Hansen.
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Market sensitivity to forward guidance was highlighted earlier this year when the Fed's new chief Janet Yellen said an interest rate hike could follow about six months after the end of the central bank's bond-buying program.

The remarks triggered a sell-off in global stock and bond markets, while futures traders moved to price in the first rate hike as soon as April 2015 from July.

Dallas Federal Reserve Bank President Richard Fischer said in April that the central bank must avoid being committed to calendar-based policy commitments and make sure that any forward guidance is flexible and can adapt to changing circumstances.

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Asked whether the Fed should consider removing its forward guidance, Hanson said: "I would like to see forward guidance be real forward guidance and have some precision to the commitment."

The Fed last week concluded a two-day meeting with a decision to scale back its monthly asset purchases by $10 billion to $35 billion. It reiterated that interest rates would remain near zero "for a considerable time" after the bond buying ends.

Financial markets are anticipating a rise in rates around the middle of next year as the economy recovers.

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On Wednesday, Philadelphia Fed chief Charles Plosser was quoted by Reuters saying he had "growing concerns that we may have to adjust our communications in the not-too-distant future. Specifically, I believe the forward guidance in the statement may be too passive."

"I think there's a serious chance we could get a hike before mid-2015," Bank of Singapore Chief Economist told CNBC. "Look at the inflation numbers, there's been a serious inflection there."

Data last week showed U.S. consumer prices recorded their largest increase in more than a year in May.