Tag Archives: imperfect credibility

The Forward Guidance Paradox

Alex Haberis, Richard Harrison and Matt Waldron.

In textbook models of monetary policy, a promise to hold interest rates lower in the future has very powerful effects on economic activity and inflation today.   This result relies on: a) a strong link between expected future policy rates and current activity; b) a belief that the policymaker will make good on the promise.  We draw on analysis from our Staff Working Paper and show that there is a tension between (a) and (b) that creates a paradox: the stronger the expectations channel, the less likely it is that people will believe the promise in the first place.   As a result, forward guidance promises in these models are much less powerful than standard analysis suggests.

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Filed under Macroeconomics, Monetary Policy, New Methodologies