Friday, Jan. 5, 2018 8:00 AM - 10:00 AM
- Chair: Benoit Mojon, Bank of France
Forward Guidance and Heterogeneous Beliefs
AbstractCentral banks' announcements that future rates are expected to remain low for some time could signal either a weak future macroeconomic outlook—which is bad news—or a more accommodative policy stance—which is good news. We use the Survey of Professional Forecasters to show that, when the Fed gave date-based forward guidance between 2011Q3 and 2012Q4, these two interpretations coexisted despite a consensus that rates would stay low for long. We rationalize these facts in an otherwise standard New-Keynesian model where agents: (i) are uncertain about the length of the trap, (ii) have different priors on the commitment ability of the central bank, and (iii) perceive central bank announcements of expected rates as accurate. This heterogeneity of beliefs introduces a trade-off in forward guidance policy: leveraging on the optimism of those who believe the centeal bank can commit comes at the cost of inducing excess pessimism in non-believers. When pessimists views prevail, forward guidance can even be detrimental.
Forward Guidance Without Common Knowledge
AbstractHow does the economy respond to news about future policies or future fundamentals? Workhorse models answer this question by imposing common knowledge of the news and of their likely effects. Relaxing this assumption anchors the expectations of future outcomes, effectively leading to heavier discounting of the future. By the same token, general-equilibrium mechanisms that hinge on forward-looking expectations, such as the Keynesian feedback loop between inflation and spending, are attenuated. We establish these insights within a class of games (“dynamic beauty contests”) which nest the New Keynesian model along with other applications. We next show how these insights help resolve the forward-guidance puzzle and offer a rationale for the front-loading of fiscal stimuli.
Monetary Policy, Bounded Rationality, and Incomplete Markets
AbstractThis paper extends the benchmark New-Keynesian model with a representative agent and rational expectations by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is much more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model. We conclude that the interaction of bounded rationality and market frictions improves the ability of the model to account for the effects of monetary policy.
Martin S. Eichenbaum,
Marco Del Negro,
Federal Reserve Bank of New York
- E3 - Prices, Business Fluctuations, and Cycles
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit