This paper examines the policy experience of the Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of Japan (BOJ) during and after the Covid-19 pandemic and draws lessons for monetary policy strategy and its communication. All three central banks provided appropriate accommodation during the pandemic but two failed to unwind this accommodation in a timely manner. The Fed and the ECB guided real interest rates to inappropriately negative levels as the economy recovered from the pandemic, fueling high inflation. The policy error can be traced to decisions regarding forward guidance on policy rates that delayed lift-off while the two central banks continued to expand their balance sheets. The Fed and the ECB fell into the forward guidance trap. This could have been avoided if policy were guided by a forward-looking rule that properly adjusted the nominal interest rate with the evolution of the inflation outlook.
Keywords: Monetary policy strategy; Forward guidance; Policy rules
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.