Should We Be Puzzled by Forward Guidance?

Brent Bundick and Andrew Smith

No RWP 20-01, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated using impulse response matching, forward guidance shocks produce an elasticity of output with respect to expected interest rates similar to our empirical estimates. Our results suggest that standard macroeconomic models do not overstate the observed sensitivity of output to expected interest rates.

Keywords: Forward Guidance; Monetary Policy Shocks; Zero Lower Bound; Impulse Response Matching (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 42
Date: 2020-04-30
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedkrw:87883

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DOI: 10.18651/RWP2020-01

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