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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.
JEL Classification: E32; E52
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 External Linkhttps://doi.org/10.18651/RWP2020-01