Managing Expectations: Instruments vs. Targets

George-Marios Angeletos and Karthik A. Sastry

No 25404, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Should policymakers offer forward guidance in terms of a path for an instrument such as interest rates or a target for an outcome such as unemployment? We study how the optimal approach depends on a departure from rational expectations. People have a limited understanding of the behavior of others and of the general equilibrium (GE) effects of policy. The bite of such bounded rationality on implementability and welfare is minimized by target-based guidance if and only if GE feedbacks are strong enough. This offers a rationale for why central banks should shine the spotlight on unemployment when faced with a prolonged liquidity trap, a steep Keynesian cross, or a large financial accelerator.

JEL-codes: D82 D84 E03 E52 E58 (search for similar items in EconPapers)
Date: 2018-12
New Economics Papers: this item is included in nep-cba, nep-mac and nep-upt
Note: EFG ME
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Citations: View citations in EconPapers (7)

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