Working Paper: CEPR ID: DP13383
Authors: Lilia Maliar; John B. Taylor
Abstract: We study the impact of forward guidance--non-systematic announcements about future policy rates -- in a stylized new Keynesian model. Using novel closed-form solutions, we show that the impact of forward guidance depends critically on the systematic monetary policy rule, ranging from non-existing to unrealistically large, the so-called forward guidance puzzle. We demonstrate that the puzzle occurs only under relatively passive -- empirically implausible and socially suboptimal -- policy rules, while more active empirically-relevant Taylor rules lead to sensible implications. Our analysis encompasses the case of a fixed interest-rate path, which characterizes effective lower-bound (ELB) periods. We conclude that it is not ELB per se that produces backward explosion but the passivity of monetary policy rules.
Keywords: forward guidance; New Keynesian model; Taylor rule
JEL Codes: C61; C63; C68; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forward guidance announcements (E60) | Economic outcomes (F69) |
| Passive monetary policy rules (E63) | Backward explosions in output and inflation (E31) |
| Active monetary policy rules (E52) | Mitigation of forward guidance effects (E60) |
| Responsiveness in monetary policy rule (E52) | Stability of the economy (E32) |
| Insufficient responsiveness in monetary policy rule (E61) | Instability of the economy (E32) |
| Overly passive policy rules (E63) | Forward guidance puzzle (C73) |