IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/13383.html
   My bibliography  Save this paper

Taylor Rules and Forward Guidance: A Rule is not a Path

Author

Listed:
  • Taylor, John

Abstract

We study the impact of forward guidance--non-systematic announcements about future policy rates -- in a stylized new Keynesian model. Using novel closed-form solutions, we show that the impact of forward guidance depends critically on the systematic monetary policy rule, ranging from non-existing to unrealistically large, the so-called forward guidance puzzle. We demonstrate that the puzzle occurs only under relatively passive -- empirically implausible and socially suboptimal -- policy rules, while more active empirically-relevant Taylor rules lead to sensible implications. Our analysis encompasses the case of a fixed interest-rate path, which characterizes effective lower-bound (ELB) periods. We conclude that it is not ELB per se that produces backward explosion but the passivity of monetary policy rules.

Suggested Citation

  • Taylor, John, 2018. "Taylor Rules and Forward Guidance: A Rule is not a Path," CEPR Discussion Papers 13383, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13383
    as

    Download full text from publisher

    File URL: https://cepr.org/publications/DP13383
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(4), pages 1371-1406.
    2. Brent Bundick & A. Lee Smith, 2020. "The Dynamic Effects of Forward Guidance Shocks," The Review of Economics and Statistics, MIT Press, vol. 102(5), pages 946-965, December.
    3. Carlstrom, Charles T. & Fuerst, Timothy S. & Paustian, Matthias, 2015. "Inflation and output in New Keynesian models with a transient interest rate peg," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 230-243.
    4. Lilia Maliar & Serguei Maliar & John B. Taylor & Inna Tsener, 2020. "A tractable framework for analyzing a class of nonstationary Markov models," Quantitative Economics, Econometric Society, vol. 11(4), pages 1289-1323, November.
    5. Iván Werning, 2015. "Incomplete Markets and Aggregate Demand," NBER Working Papers 21448, National Bureau of Economic Research, Inc.
    6. John H. Cochrane, 2011. "Determinacy and Identification with Taylor Rules," Journal of Political Economy, University of Chicago Press, vol. 119(3), pages 565-615.
    7. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828, Elsevier.
    8. Marco Del Negro & Marc P. Giannoni & Christina Patterson, 2023. "The Forward Guidance Puzzle," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(1), pages 43-79.
    9. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
    10. Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Forward Guidance And The State Of The Economy," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1593-1624, October.
    11. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    12. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(4), pages 1371-1406.
    13. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2016. "The Power of Forward Guidance Revisited," American Economic Review, American Economic Association, vol. 106(10), pages 3133-3158, October.
    14. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    16. Taylor, John B., 1986. "New econometric approaches to stabilization policy in stochastic models of macroeconomic fluctuations," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 3, chapter 34, pages 1997-2055, Elsevier.
    17. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2017. "The Discounted Euler Equation: A Note," Economica, London School of Economics and Political Science, vol. 84(336), pages 820-831, October.
    18. Cochrane, John H., 2017. "The new-Keynesian liquidity trap," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 47-63.
    19. Andrew Levin & David López-Salido & Edward Nelson & Yack Yun, 2010. "Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, vol. 6(1), pages 143-189, March.
    20. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
    21. David L. Reifschneider & John C. Williams, 2000. "Three lessons for monetary policy in a low-inflation era," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 936-978.
    22. Maliar, Lilia, 2018. "Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap," CEPR Discussion Papers 13384, C.E.P.R. Discussion Papers.
    23. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
    24. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    25. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    RePEc Biblio mentions

    As found on the RePEc Biblio, the curated bibliography for Economics:
    1. > Macroeconomics > Monetary Theory

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:zbw:bofrdp:2019_019 is not listed on IDEAS
    2. Christian Pfister & Jean-Guillaume Sahuc, 2020. "Unconventional monetary policies: A stock-taking exercise," Revue d'économie politique, Dalloz, vol. 130(2), pages 137-169.
    3. Lilia Maliar & Serguei Maliar & John B. Taylor & Inna Tsener, 2020. "A tractable framework for analyzing a class of nonstationary Markov models," Quantitative Economics, Econometric Society, vol. 11(4), pages 1289-1323, November.
    4. Maliar, Lilia, 2018. "Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap," CEPR Discussion Papers 13384, C.E.P.R. Discussion Papers.
    5. 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.
    6. Naubert, Christopher, 2019. "Monetary Policy and Redistribution: A Look under the Hatch with TANK," CEPR Discussion Papers 14159, C.E.P.R. Discussion Papers.
    7. repec:zbw:bofrdp:019 is not listed on IDEAS
    8. Gibbs, Christopher G. & McClung, Nigel, 2019. "Does my model predict a forward guidance puzzle?," Research Discussion Papers 19, Bank of Finland.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lilia Maliar & John B. Taylor, 2019. "Forward Guidance: Is It Useful Away from the Lower Bound?," NBER Working Papers 26053, National Bureau of Economic Research, Inc.
    2. Tom D. Holden, 2023. "Existence and Uniqueness of Solutions to Dynamic Models with Occasionally Binding Constraints," The Review of Economics and Statistics, MIT Press, vol. 105(6), pages 1481-1499, November.
    3. Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Forward Guidance And The State Of The Economy," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1593-1624, October.
    4. Guido Ascari & Argia M. Sbordone, 2014. "The Macroeconomics of Trend Inflation," Journal of Economic Literature, American Economic Association, vol. 52(3), pages 679-739, September.
    5. Lindé, Jesper & Smets, Frank & Wouters, Rafael, 2016. "Challenges for Central Banks´ Macro Models," Working Paper Series 323, Sveriges Riksbank (Central Bank of Sweden).
    6. Lilia Maliar & Serguei Maliar & John B. Taylor & Inna Tsener, 2020. "A tractable framework for analyzing a class of nonstationary Markov models," Quantitative Economics, Econometric Society, vol. 11(4), pages 1289-1323, November.
    7. Proaño, Christian R. & Lojak, Benjamin, 2020. "Animal spirits, risk premia and monetary policy at the zero lower bound," Journal of Economic Behavior & Organization, Elsevier, vol. 171(C), pages 221-233.
    8. de Groot, Oliver & Haas, Alexander, 2023. "The signalling channel of negative interest rates," Journal of Monetary Economics, Elsevier, vol. 138(C), pages 87-103.
    9. Mariana García-Schmidt & Michael Woodford, 2019. "Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis," American Economic Review, American Economic Association, vol. 109(1), pages 86-120, January.
    10. Dobrew, Michael & Gerke, Rafael & Giesen, Sebastian & Röttger, Joost, 2023. "Make-up strategies with incomplete markets and bounded rationality," Discussion Papers 01/2023, Deutsche Bundesbank.
    11. Lindé, J. & Smets, F. & Wouters, R., 2016. "Challenges for Central Banks’ Macro Models," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2185-2262, Elsevier.
    12. Robert Amano & Malik Shukayev, 2012. "Risk Premium Shocks and the Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(8), pages 1475-1505, December.
    13. Hess Chung & Edward Herbst & Michael T. Kiley, 2015. "Effective Monetary Policy Strategies in New Keynesian Models: A Reexamination," NBER Macroeconomics Annual, University of Chicago Press, vol. 29(1), pages 289-344.
    14. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 87-112, Summer.
    15. Roberto M. Billi, 2020. "Output Gaps and Robust Monetary Policy Rules," International Journal of Central Banking, International Journal of Central Banking, vol. 16(2), pages 125-152, March.
    16. Maliar, Lilia, 2018. "Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap," CEPR Discussion Papers 13384, C.E.P.R. Discussion Papers.
    17. Billi, Roberto M., 2018. "Price level targeting and risk management," Economic Modelling, Elsevier, vol. 73(C), pages 163-173.
    18. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(4), pages 1371-1406.
    19. Erceg, Christopher J. & Jakab, Zoltan & Lindé, Jesper, 2021. "Monetary policy strategies for the European Central Bank," Journal of Economic Dynamics and Control, Elsevier, vol. 132(C).
    20. Stephen J. Cole, 2021. "Learning and the Effectiveness of Central Bank Forward Guidance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(1), pages 157-200, February.

    More about this item

    Keywords

    Forward guidance; New keynesian model;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:13383. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.