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Stabilization and expanded commitment: a theory of forward guidance for economies with rational expectations

Author

Listed:
  • Hughes Hallett Andrew

    (Department of Public Policy – George Mason University Fairfax Drive, Arlington (USA))

  • Nicola Acocella

    (Department of Methods and Models for Economics, Territory and Finance, Sapienza University of Rome (Italy))

Abstract

In this paper we construct a general theory of forward guidance in economic policy making, in order to provide a framework to explain the role and strategic advantages of including forward guidance as an explicit part of policy design. We do this by setting up a general policy problem in which forward guidance plays a role and then examine the consequences for performance when that guidance is withdrawn. Following results in Acocella et al (2013), who extend the theory of economic policy to a world with rational expectations, we show that forward guidance provides enhanced controllability and stabilizability – especially where such properties have not been available before. As a by-product we find that forward guidance severely limits the scope and incentives for time inconsistent behaviour in an economy whose policy goals are ultimately reachable. It can therefore add to the credibility of a set of policies.

Suggested Citation

  • Hughes Hallett Andrew & Nicola Acocella, "undated". "Stabilization and expanded commitment: a theory of forward guidance for economies with rational expectations," Working Papers 132/14, Sapienza University of Rome, Metodi e Modelli per l'Economia, il Territorio e la Finanza MEMOTEF.
    • Handle: RePEc:rsq:wpaper:31/14
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    File URL: https://web.uniroma1.it/memotef/sites/default/files/wpapers/documenti/FullTextWP132.pdf
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    References listed on IDEAS

    as
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    2. Acocella,Nicola & Di Bartolomeo,Giovanni & Hughes Hallett,Andrew, 2018. "The Theory of Economic Policy in a Strategic Context," Cambridge Books, Cambridge University Press, number 9781108468824.
    3. Joseph Gagnon & Matthew Raskin & Julie Remache & Brian Sack, 2011. "The Financial Market Effects of the Federal Reserve's Large-Scale Asset Purchases," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 3-43, March.
    4. 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.
    5. 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.
    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. Frederic S. Mishkin, 2002. "The Role of Output Stabilization in the Conduct of Monetary Policy," NBER Working Papers 9291, National Bureau of Economic Research, Inc.
    8. Clemens J. M. Kool & Daniel L. Thornton, 2015. "How Effective Is Central Bank Forward Guidance?," Review, Federal Reserve Bank of St. Louis, vol. 97(4), pages 303-322.
    9. Nicola Acocella & Giovanni Di Bartolomeo & Andrew Hughes Hallett & Paolo G. Piacquadio, 2014. "Announcements as an equilibrium selection device," Oxford Economic Papers, Oxford University Press, vol. 66(1), pages 325-347, January.
    10. Silvio Contessi & Li Li, 2013. "Forward guidance 101A: a roadmap of the U.S. experience," Economic Synopses, Federal Reserve Bank of St. Louis.
    11. Frederic S. Mishkin, 2002. "The Role of Output Stabilization in the Conduct of Monetary Policy," International Finance, Wiley Blackwell, vol. 5(2), pages 213-227.
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    13. Fisher, P. G. & Hallett, A. J. Hughes, 1988. "Efficient solution techniques for linear and non-linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 12(4), pages 635-657, November.
    14. William T. Gavin & Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "The stimulative effect of forward guidance," Working Papers 2013-38, Federal Reserve Bank of St. Louis.
    15. Andrew Hughes Hallett & Rasmus Kattai & John Lewis, 2012. "How Reliable Are Cyclically Adjusted Budget Balances In Real Time?," Contemporary Economic Policy, Western Economic Association International, vol. 30(1), pages 75-92, January.
    16. Hughes Hallett, Andrew & Di Bartolomeo, Giovanni & Acocella, Nicola, 2012. "A general theory of controllability and expectations anchoring for small-open economies," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 397-411.
    17. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
    18. Hughes Hallett Andrew & Acocella Nicola & Di Bartolomeo Giovanni, 2012. "Expectations Dynamics: Policy, Announcements and Limits to Dynamic Inconsistency," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(2), pages 1-25, April.
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    Cited by:

    1. Hallett, Andrew Hughes & Acocella, Nicola, 2019. "Forward guidance reassessed: Stabilizability under endogenous policy rules," Journal of Macroeconomics, Elsevier, vol. 59(C), pages 325-335.
    2. Maria Demertzis & Andrew Hughes Hallett, 2015. "Three different approaches to transparency in monetary policy," Economia Politica: Journal of Analytical and Institutional Economics, Springer;Fondazione Edison, vol. 32(3), pages 277-300, December.

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    More about this item

    Keywords

    Managing Expectations; Stabilizability; Dynamic Controllability; Time Consistency; Two point boundary solutions;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • 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

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