Disciplining expectations and the forward guidance puzzle

Tobias Müller, Kai Christoffel, Falk Mazelis and Carlos Montes-Galdón

Journal of Economic Dynamics and Control, 2022, vol. 137, issue C

Abstract: Forward guidance operates via the expectations formation process of the agents in the economy. In standard quantitative macroeconomic models, expectations are unobserved variables formed endogenously via the dynamics of the model and little scrutiny is devoted to analysing the behaviour of these expectations. We show that the introduction of survey and financial market-based forecast data in the estimation of the model disciplines the expectations formation process in DSGE models. When the model-implied expectations are matched to observed expectations, the additional information of the forecasts restrains the agents’ expectations formation. We argue that the reduced volatility of the agents’ expectations dampens the model reactions to forward guidance shocks and improves the out-of-sample forecast accuracy of the model. Furthermore, we evaluate the case for introducing a discount factor as a reduced form proxy for a variety of microfounded approaches, proposed to mitigate the forward guidance puzzle. Once data on expectations is considered, the empirical support to introduce a discount factor dissipates.

Keywords: Expectations formation; Monetary policy; Bayesian estimation; Forecasting; DSGE models (search for similar items in EconPapers)
JEL-codes: C13 C52 E3 E47 E52 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Working Paper: Disciplining expectations and the forward guidance puzzle (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:137:y:2022:i:c:s0165188922000410

DOI: 10.1016/j.jedc.2022.104336

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