Estimating the effects of forward guidance in rational expectations models

Ricahrd Harrison

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Simulations of forward guidance in rational expectations models should be assessed using the “modest interventions” framework introduced by Eric Leeper and Tao Zha. That is, the estimated effects of a policy intervention should be considered reliable only if that intervention is unlikely to trigger a revision in private sector beliefs about the way that policy will be conducted. I show how to constrain simulations of forward guidance to ensure that they are regarded as modest policy interventions and illustrate the technique using a medium-scale DSGE model estimated on US data. I find that, in many cases, experiments that generate the large responses of macroeconomic variables that many economists deem implausible – the so-called “forward guidance puzzle” – would not be viewed as modest policy interventions by the agents in the model. Those experiments should therefore be treated with caution, since they may prompt agents to believe that there has been a change in the monetary policy regime that is not accounted for within the model. More reliable results can be obtained by constraining the experiment to be a modest policy intervention. The quantitative effects on macroeconomic variables are more plausible in these cases.

JEL-codes: J1 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2014-11-06
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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