Should We Be Puzzled by Forward Guidance?

May 1, 2020
By Brent Bundick, Research and Policy Advisor , A. Lee Smith, Research and Policy Advisor


Research Working PaperForward guidance that lowers the expected path of policy continues to stimulate economic activity and prices.

Although a growing literature argues output is too sensitive to future interest rates in standard macroeconomic models, little empirical evidence has been put forth to evaluate this claim. In this paper, we use a range of vector autoregression models to answer the central question of how much output responds to changes in interest rate expectations following a monetary policy shock. Despite distinct identification strategies and sample periods, we find surprising agreement regarding this elasticity across empirical models. We then show that in a standard model of nominal rigidity estimated using impulse response matching, forward guidance shocks produce an elasticity of output with respect to expected interest rates similar to our empirical estimates. Our results suggest that standard macroeconomic models do not overstate the observed sensitivity of output to expected interest rates.

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RWP 20-01, April 2020

JEL Classification: E32; E52

Article Citation

  • Bundick, Brent, and A. Lee Smith. 2020. “Should We Be Puzzled by Forward Guidance?” Federal Reserve Bank of Kansas City, Research Working Paper no. 20-01, April. Available at https://doi.org/10.18651/RWP2020-01 

Related Research

  • Bundick, Brent, and A. Lee Smith. 2019. “The Dynamic Effects of Forward Guidance Shocks.” Federal Reserve Bank of Kansas City, Research Working Paper no. 16-02, June. Available at https://doi.org/10.18651/RWP2016-02
  • Bundick, Brent, Trenton Herriford and A. Lee Smith. 2019. “Forward Guidance, Monetary Policy Uncertainty, and the Term Premium.” Federal Reserve Bank of Kansas City, Research Working Paper no. 17-07, December. Available at https://doi.org/10.18651/RWP2017-07

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