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Using the pure expectations theory of the term structure and the associated equation for the 10...

Using the pure expectations theory of the term structure and the associated equation for the 10 yr GS, explain what forward guidance means and how the use of it is supposed to influence the economy.

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Forward guidance regarding movement of interest rates in the future helps us in determining what is going to the cost of capital for the economy going forward. This helps us in assessing the investment climate. If economic agents observe that the interest rates are going up, they develop expectations of a low investment climate. This encourages them for pulling back their investment plans.Vice-versa is also true. Economic agents observe the forecasts and behave as if those forecasts are also the current parameters of the economy.

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