The stabilizing role of forward guidance: A macro experiment

Steffen Ahrens, Joep Lustenhouwer and Michele Tettamanzi

No 137, BERG Working Paper Series from Bamberg University, Bamberg Economic Research Group

Abstract: Expectations are among the main driving forces for economic dynamics. Therefore, managing expectations has become a primary objective for monetary policy seeking to stabilize the business cycle. In this paper, we study whether central banks can manage market expectations by means of forward guidance in a New Keynesian learning-to-forecast experiment. Forward guidance takes the form of one-period ahead inflation projections that are published by the central bank in each period. Subjects in the experiment observe these projections along with the historic development of the economy and subsequently submit their own one-period ahead inflation forecasts. In this context, we find that the central bank can significantly manage market expectations through forward guidance and that this management strongly supports monetary policy in stabilizing the economy. Moreover, forward guidance drastically reduces the probability of a deflationary spiral after strong negative shocks to the economy.

Keywords: learning-to-forecast experiment; forward guidance; heterogeneous expectations (search for similar items in EconPapers)
JEL-codes: C92 E32 E37 E58 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-cba, nep-exp, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bamber:137

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