The Limits of Forward Guidance

43 Pages Posted: 16 Apr 2019 Last revised: 29 Apr 2020

See all articles by Jeffrey R. Campbell

Jeffrey R. Campbell

University of Notre Dame; Tilburg University

Filippo Ferroni

Federal Reserve Bank of Chicago

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department

Leonardo Melosi

Federal Reserve Bank of Chicago

Date Written: 2019-03-20

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 Classification: E0, E52, F44

Suggested Citation

Campbell, Jeffrey R. and Ferroni, Filippo and Fisher, Jonas D. M. and Melosi, Leonardo, The Limits of Forward Guidance (2019-03-20). FRB of Chicago Working Paper No. WP-2019-3, Available at SSRN: https://ssrn.com/abstract=3372452 or http://dx.doi.org/10.21033/wp-2019-03

Jeffrey R. Campbell (Contact Author)

University of Notre Dame ( email )

United States

Tilburg University ( email )

Tilburg, 5000 LE
Netherlands

Filippo Ferroni

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States

Leonardo Melosi

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
9
Abstract Views
229
PlumX Metrics