HT - 08. Forward Guidance

Question 1

Del Negro, Giannoni and Patterson (2012), Paustian (2012)

Levin et.al (2010), Patterson (2012), Kiley (2016)

Answer 1

Credible FG can be very powerful at ELB in NKM.

– FG puzzle: FG boosts output and inflation expectations once control for other announcement elements. Puzzle is the models dramatically over estimate its effectiveness due to lack of discounting.  Solutions? OLG (Del Negro, G & P, 2012); Heterogeneity and incomplete markets

Question 2

McKay et. Al (2016)

Answer 2

• FG: credible promises on future itnerest rates are extremely powerful, due to cumulative effects when solving equations forward

– Fg significantly weaker with incomplete markets eg. borrowing constraints or uninsurable risk

Question 3

Bilbiie (2019)

Answer 3

– drop full insurance assumption: price level targeting –> determinacy and no FG puzzle, tension between amplification and solving FG puzzle (amplification required countercyclical inequality while solving FG requires pro-cyclical)

Question 4

Campbell and Mankiw (1990), Kaplan, Violante and Weidner (2014):

Answer 4

30-60% liquidity constrained but… wealthy Hand to mouth –> low sensitivity of aggregate consumption to real interest rate Hall (1988), Yogo (2004)

Question 5

Lindé and Trabandt (2019)

Answer 5

– non-linearity matters for solving missing deflation puzzle

Question 6

Cochrane (2013)

Answer 6

NKM suffers frrom multipl equilibria, FG can take other forms around inflation rate choice post the ELB.

• Promising a little inflation even as smalla s 2% per year when ELB ends can lead to strong expansion during the ELB binding

While this looks good for the CB overcoming the ELB constraint, it may be more indicative of further questions about the NKM. Is this truly representative? Questionable role of fully rational expectations and the current impact of future variables.