Forward Guidance Could Work for Governments Too, ECB Study Shows
(Bloomberg) -- Governments should take a leaf from the central-banking playbook and signpost their fiscal plans, according to research published by the European Central Bank.
“Our analysis highlights the case for policy signaling as a tool to reduce disagreement and enhance the impact of spending shocks,” ECB economists Giovanni Callegari and Jacopo Cimadomo and the University of Warwick’s Giovanni Ricco said in a working paper published on Friday. “Fiscal communication can be used as a forward-guidance tool i.e. by committing to a future path of policy, fiscal authorities tend to generate stronger effects on the economy.”
Monetary officials have been using guidance since the early 2000s to give investors more information about the expected trajectory of interest rates, with the aim of reducing uncertainty and increasing the impact of decisions. While the merits are debated in academic circles, central banks including the U.S. Federal Reserve, ECB and Bank of England consider it a key part of the policy mix as they strive to hit their inflation targets.
Drawing mostly from U.S. data, the researchers constructed an “index for fiscal-policy disagreement” based on professional forecasts for public spending, and compared it with the effectiveness of government stimulus decisions. They concluded that spending shocks have a greater impact if disagreement over fiscal policy is low, mainly due to an accelerator effect on investment.
“Authorities have several concrete options in using this tool,” the authors wrote. “For example, they can accompany the announcement of fiscal targets with a clear indication of the measures that they intend to adopt to achieve them. This should reduce the risks of changes in the fiscal strategy in its implementation phase, thus decreasing disagreement.”