Nobel Prize Slaps Walsh: Who Says Forward Guidance Is Useless!?

At his very first interest rate meeting in June after taking office, Fed Chair Walsh announced, “We have abandoned forward guidance,” and in September he again refused to provide his own forecasts in the dot plot, arguing that the market should “watch the ball, not the referee.”

Four months later, on October 12, the Royal Swedish Academy of Sciences awarded this year's Nobel Prize in Economics to Robert E. Hall of Stanford University and Michael Woodford of Columbia University—the latter being the theoretical source of forward guidance, whose lifelong central belief is summed up in one phrase: a central bank’s ability to manage expectations is more important than the interest rate itself.

The selection committee gave the following reason for the award: whether households are spending or businesses are setting prices, they are both planning for tomorrow—to stabilize the economy, the central bank must manage everyone’s expectations about the future, and the most crucial way to manage expectations is through communication.

This may sound like common sense, but economists spent decades turning this from intuition into usable, calculable models—the reason being that the previous generation of Keynesian models had a fatal bug.