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Rethinking the Power of Forward Guidance: Lessons from Japan

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  • Mark Gertler

Abstract

In the spring of 2013 the Bank of Japan introduced a state-of-the-art monetary policy which included among other things inflation targeting and aggressive use of forward guidance. In contrast to the predictions of conventional macroeconomic theory, these policies have had only very limited success in reflating the economy. I argue that the disconnect between the Japanese experience and existing theory can be traced to the forward guidance puzzle (FGP). As recent literature suggests, the essence of the FGP is that existing models predict implausibly strong effects of expected future interest rate changes on the economy,.with the strength of the effect increasing with the expected horizon of the interest rate change. Accordingly, in this lecture I sketch a model meant to capture the challenge of reflation in Japan. As in recent literature I attempt to mute the power of forward guidance by stepping outside of rational expectations. In particular I introduce a hybrid adaptive/rational expectations belief mechanism. Most relevant to the Japanese experience is that individuals have adaptive expectations about trend inflation, which is consistent with the evidence. As Kuroda (2016) emphasizes, for an economy without a history of inflation being anchored by a target, individuals need direct evidence that the central bank is capable of moving inflation to target.

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  • Mark Gertler, 2017. "Rethinking the Power of Forward Guidance: Lessons from Japan," NBER Working Papers 23707, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:23707
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    References listed on IDEAS

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    1. George-Marios Angeletos & Chen Lian, 2016. "Forward Guidance without Common Knowledge," NBER Working Papers 22785, National Bureau of Economic Research, Inc.
    2. Olivier Coibion & Yuriy Gorodnichenko, 2012. "What Can Survey Forecasts Tell Us about Information Rigidities?," Journal of Political Economy, University of Chicago Press, vol. 120(1), pages 116-159.
    3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    4. Emmanuel Farhi & Iván Werning, 2017. "Monetary Policy, Bounded Rationality, and Incomplete Markets," NBER Working Papers 23281, National Bureau of Economic Research, Inc.
    5. Gabaix, Xavier, 2016. "A Behavioral New Keynesian Model," CEPR Discussion Papers 11729, C.E.P.R. Discussion Papers.
    6. Mariana García-Schmidt & Michael Woodford, 2019. "Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis," American Economic Review, American Economic Association, vol. 109(1), pages 86-120, January.
    7. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2016. "The Power of Forward Guidance Revisited," American Economic Review, American Economic Association, vol. 106(10), pages 3133-3158, October.
    8. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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    Cited by:

    1. Barbosa, Fernando de Holanda, 2018. "Is the new keynesian is curve forward looking?," FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) 797, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil).
    2. Beqiraj, Elton & Di Bartolomeo, Giovanni & Di Pietro, Marco, 2019. "Beliefs formation and the puzzle of forward guidance power," Journal of Macroeconomics, Elsevier, vol. 60(C), pages 20-32.
    3. repec:bla:jecsur:v:32:y:2018:i:5:p:1229-1256 is not listed on IDEAS

    More about this item

    JEL classification:

    • 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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