Forward Guidance: Communication, Commitment, or Both?

Faced with the constraint of the zero lower bound on interest rates, central banks around the world have engaged in "forward guidance" as one instrument to stimulate the economy. To properly ascertain the potential benefits of forward guidance as an independent tool of monetary policy, it is important to understand how it can work. Forward guidance comes in two different versions, which have been defined as "Odyssean" and "Delphic." Under Delphic forward guidance, the central bank communicates private information to the public, which is relevant to forecast the future path of monetary policy. In contrast, Odyssean forward guidance communicates a path to which monetary authorities wish to commit in order to avoid time inconsistency. Forward guidance of either sort is conducted by means of public statements; these statements do not bind the actions of the central bank directly. Nonetheless, deviating from a previously-announced path can be costly ex post, because it affects credibility. I analyze the strategic interaction between households and the central bank as a game in which the central bank has access to cheap talk. In the absence of private information, I prove that the set of equilibria is independent of the announcements of the central bank; hence, pure Odyssean forward guidance does not expand the set of possible equilibrium outcomes. There is no need for the central bank to communicate its commitment to support a trigger-strategy equilibrium. However, when private information is present and Delphic forward guidance has social value, there exist equilibria in which central bank communications act as a substitute for commitment: in this case, the potential loss of credibility acts as a further deterrent against ex post deviations.