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The forward guidance puzzle

  • Del Negro, Marco

    (Federal Reserve Bank of New York)

  • Giannoni, Marc

    (Federal Reserve Bank of New York)

  • Patterson, Christina

    (Massachusetts Institute of Technology)

With short-term interest rates at the zero lower bound, forward guidance has become a key tool for central bankers, and yet we know little about its effectiveness. This paper first empirically documents the impact of forward guidance announcements on a broad cross section of financial markets data and professional forecasts. We find that Federal Open Market Committee (FOMC) announcements containing forward guidance had heterogeneous effects depending on the other content of the statement. We show that once we control for these other elements, forward guidance had, on average, positive and meaningful effects on output and inflation expectations. Using this benchmark, we then show that standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy, a phenomenon we call the “forward guidance puzzle.” We explain why this is the case and show that incorporating a perpetual youth structure into the benchmark provides a possible resolution to the puzzle.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 574.

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Length: 81 pages
Date of creation: 2012
Date of revision: 01 Dec 2015
Handle: RePEc:fip:fednsr:574
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  1. Gurkaynak, Refet S & Sack, Brian & Swanson, Eric T, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," MPRA Paper 820, University Library of Munich, Germany.
  2. Rochelle M. Edge & Refet S. Gurkaynak, 2010. "How Useful Are Estimated DSGE Model Forecasts for Central Bankers?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 41(2 (Fall)), pages 209-259.
  3. Michael D. Bauer & Glenn D. Rudebusch, 2011. "The signaling channel for Federal Reserve bond purchases," Working Paper Series 2011-21, Federal Reserve Bank of San Francisco.
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