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The Power of Forward Guidance and the Fiscal Theory of the Price Level

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  • Nigel McClung

    (Bank of Finland)

Abstract

Standard models predict implausible responses to forward-guidance announcements when interest rates are pegged (the "forward-guidance puzzle"). This paper develops conditions for regime-switching models to exhibit a forward-guidance puzzle,and shows when the fiscal theory of the price level does-and does not-resolve the forward-guidance puzzle. Forward guidance has reasonable effects when real fiscal revenues are very unresponsive to government debt, but in some empirically relevant cases, inflation must ensure debt stability and forward-guidance puzzles are still there. Cyclical variation in deficits also affects the power of forward guidance.

Suggested Citation

  • Nigel McClung, 2021. "The Power of Forward Guidance and the Fiscal Theory of the Price Level," International Journal of Central Banking, International Journal of Central Banking, vol. 17(71), pages 1-57, December.
    • Handle: RePEc:ijc:ijcjou:y:2021:q:5:a:3
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    References listed on IDEAS

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    Cited by:

    1. Christopher Gibbs & Nigel McClung, 2023. "Does my model predict a forward guidance puzzle?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 393-423, December.
    2. Christopher Gibbs & Nigel McClung, 2023. "Does my model predict a forward guidance puzzle?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 393-423, December.
    3. Eskelinen, Maria & Gibbs, Christopher G. & McClung, Nigel, 2024. "Resolving new keynesian puzzles," Bank of Finland Research Discussion Papers 5/2024, Bank of Finland.

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    More about this item

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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