Working Paper: CEPR ID: DP13612
Authors: Jeffrey R. Campbell; Filippo Ferroni; Jonas Fisher; Leonardo Melosi
Abstract: The viability of forward guidance as a monetary policy tool depends on the horizon over which it can be communicated and its influence on expectations over that horizon. We develop and estimate a model of imperfect central bank communications and use it to measure how effectively the Fed has managed expectations about future interest rates and the influence of its communications on macroeconomic outcomes. Standard models assume central banks have perfect control over expectations about the policy rate up to an arbitrarily long horizon and this is the source of the so-called "forward guidance puzzle.'' Our estimated model suggests that the Fed's ability to affect expectations at horizons that are sufficiently long to give rise to the forward guidance puzzle is substantially limited. We also find that imperfect communication has a significant impact on the propagation of forward guidance. Finally, we develop a novel decomposition of the response of the economy to forward guidance and use it to show that empirically plausible imperfect forward guidance has a quantitatively important role bringing forward the effects of future rate changes and that poor communications have been a source of macroeconomic volatility.
Keywords: monetary policy; forward guidance puzzle; central bank communication; business cycles; risk management
JEL Codes: E0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Imperfect communication (D83) | Limited ability of the Fed to affect expectations at long horizons (D84) |
| Imperfect communication (D83) | Impact on propagation of forward guidance (E60) |
| Forward guidance (Y20) | Macroeconomic outcomes (E19) |
| Poor communications (L96) | Macroeconomic volatility (E39) |
| Imperfect communication (D83) | Delayed and amplified response of the economy to monetary shocks (E39) |