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The Puzzle, the Power, and the Dark Side: Forward Guidance Redux

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  • Bilbiie, Florin

Abstract

Forward guidance (FG) is phenomenally powerful in New Keynesian models---a feature that earned the label "FG puzzle". This paper shows formally how two channels are jointly necessary to reduce the power enough to resolve the puzzle: hand-to-mouth constrained households' income respond to aggregate less than one-to-one; and unconstrained households self-insure idiosyncratic risk. These channels are complementary: if the former condition fails, FG power is instead amplified and the puzzle aggravated. Yet optimal policy does not imply larger FG duration even with such puzzling amplification, because FG power has a dark side: when it increases, so does its welfare cost.

Suggested Citation

  • Bilbiie, Florin, 2017. "The Puzzle, the Power, and the Dark Side: Forward Guidance Redux," CEPR Discussion Papers 12231, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12231
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    Cited by:

    1. Nicolas Caramp & Dejanir Silva, 2019. "Fiscal Origins of Monetary Paradoxes," 2019 Meeting Papers 1281, Society for Economic Dynamics.

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    More about this item

    Keywords

    Heterogenous households; Forward guidance;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • 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
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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