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The Limits of Forward Guidance

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  • Campbell, Jeffrey R
  • Ferroni, Filippo
  • Fisher, Jonas
  • Melosi, Leonardo

Abstract

The viability of forward guidance as a monetary policy tool depends on the horizon over which it can be communicated and its influence on expectations over that horizon. We develop and estimate a model of imperfect central bank communications and use it to measure how effectively the Fed has managed expectations about future interest rates and the influence of its communications on macroeconomic outcomes. Standard models assume central banks have perfect control over expectations about the policy rate up to an arbitrarily long horizon and this is the source of the so-called "forward guidance puzzle.'' Our estimated model suggests that the Fed's ability to affect expectations at horizons that are sufficiently long to give rise to the forward guidance puzzle is substantially limited. We also find that imperfect communication has a significant impact on the propagation of forward guidance. Finally, we develop a novel decomposition of the response of the economy to forward guidance and use it to show that empirically plausible imperfect forward guidance has a quantitatively important role bringing forward the effects of future rate changes and that poor communications have been a source of macroeconomic volatility.

Suggested Citation

  • Campbell, Jeffrey R & Ferroni, Filippo & Fisher, Jonas & Melosi, Leonardo, 2019. "The Limits of Forward Guidance," CEPR Discussion Papers 13612, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13612
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    Cited by:

    1. Bassetto, Marco, 2019. "Forward guidance: Communication, commitment, or both?," Journal of Monetary Economics, Elsevier, vol. 108(C), pages 69-86.
    2. Bielecki, Marcin & Brzoza-Brzezina, Michał & Kolasa, Marcin, 2019. "Comment on “The limits of forward guidance” by Jeffrey R. Campbell, Filippo Ferroni, Jonas D. M. Fisher and Leonardo Melosi," Journal of Monetary Economics, Elsevier, vol. 108(C), pages 135-139.
    3. Airaudo, Marco, 2020. "Temptation and forward-guidance," Journal of Economic Theory, Elsevier, vol. 186(C).
    4. Stephen J. Cole & Enrique Martínez-García, 2019. "The Effect of Central Bank Credibility on Forward Guidance in an Estimated New Keynesian Model," Globalization Institute Working Papers 375, Federal Reserve Bank of Dallas.

    More about this item

    Keywords

    business cycles; central bank communication; forward guidance puzzle; monetary policy; Risk management;

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General

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