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Macro coordination: Forward Guidance as ‘cheap talk’?

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  • Miller, Marcus
  • Zhang, Lei

Abstract

In the context of revived output growth and business confidence in the UK, we analyse forward guidance as a ‘coordination device’, indicating that monetary accommodation will be available for a welcome and long-awaited shift out of prolonged recession. As David Miles has emphasised, however, the existence of multiple equilibria is a necessary condition for costless and non-binding messages – so-called “cheap talk” – to act in this way. By way of microfoundations, we appeal to Peter Diamond’s classic model of search, where the positive externalities offered by ‘thick’ markets can generate different equilibrium levels of production. What of the objection that “cheap talk” by the MPC may be used deliberately to mislead the Private Sector in order to assist the MPC achieve its objectives? We show that this is not true for symmetric inflation targeting, where ‘cheap talk’ selects the Pareto dominant equilibrium. (This contrasts with the case where high inflation is penalised, but not below target inflation).

Suggested Citation

  • Miller, Marcus & Zhang, Lei, 2014. "Macro coordination: Forward Guidance as ‘cheap talk’?," CEPR Discussion Papers 9975, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9975
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    References listed on IDEAS

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    1. Cooper,Russell, 1999. "Coordination Games," Cambridge Books, Cambridge University Press, number 9780521578967, December.
    2. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-894, October.
    3. Farmer, Roger, 2013. "The Natural Rate Hypothesis: an idea past its sell-by date," Bank of England Quarterly Bulletin, Bank of England, vol. 53(3), pages 244-256.
    4. Manning, Alan, 1990. "Imperfect Competition, Multiple Equilibria and Unemployment Policy," Economic Journal, Royal Economic Society, vol. 100(400), pages 151-162, Supplemen.
    5. Joseph Farrell & Matthew Rabin, 1996. "Cheap Talk," Journal of Economic Perspectives, American Economic Association, vol. 10(3), pages 103-118, Summer.
    6. Yann Algan & Xavier Ragot, 2010. "Monetary policy with Heterogeneous Agents and Borrowing Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(2), pages 295-316, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    cheap-talk; coordination problems; equilibrium selection; monetary policy; multiple equilibria;

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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