Working Paper: CEPR ID: DP9975
Authors: Marcus Miller; Lei Zhang
Abstract: In the context of revived output growth and business confidence in the UK, we analyse forward guidance as a ?coordination device?, indicating that monetary accommodation will be available for a welcome and long-awaited shift out of prolonged recession.As David Miles has emphasised, however, the existence of multiple equilibria is a necessary condition for costless and non-binding messages ? so-called ?cheap talk? ? to act in this way. By way of microfoundations, we appeal to Peter Diamond?s classic model of search, where the positive externalities offered by ?thick? markets can generate different equilibrium levels of production.What of the objection that ?cheap talk? by the MPC may be used deliberately to mislead the Private Sector in order to assist the MPC achieve its objectives? We show that this is not true for symmetric inflation targeting, where ?cheap talk? selects the Pareto dominant equilibrium. (This contrasts with the case where high inflation is penalised, but not below target inflation).
Keywords: cheap talk; coordination problems; equilibrium selection; monetary policy; multiple equilibria
JEL Codes: C72; E31; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| forward guidance (E60) | coordination device (Y20) |
| multiple equilibria (D50) | cheap talk influences expectations (D84) |
| cheap talk (C79) | Pareto dominant equilibrium (D51) |
| MPC communication (E42) | private sector expectations (E69) |
| private sector expectations (E69) | productivity outcomes (O49) |
| productivity outcomes (O49) | inflation outcomes (E31) |
| low policy rates (E43) | productivity growth (O49) |
| MPC's credibility (E51) | private sector belief in promises (P14) |