The Dynamic Effects of Forward Guidance Shocks

Abstract

We examine the macroeconomic effects of forward guidance shocks at the zero lower bound. Empirically, we identify forward guidance shocks using unexpected changes in futures contracts around monetary policy announcements. We then embed these policy shocks in a vector autoregression to trace out their macroeconomic implications. Forward guidance shocks that lower expected future policy rates lead to moderate increases in economic activity and inflation. After examining forward guidance shocks in the data, we show that a standard model of nominal price rigidity can reproduce our empirical findings. To estimate our theoretical model, we generate a model-implied futures curve which closely links our model with the data. Our results suggest no disconnect between the empirical effects of forward guidance shocks around policy announcements and the predictions from a standard theoretical model.

Has the Information Channel of Monetary Policy Disappeared? Revisiting the Empirical Evidence

“…On the other hand,Bundick and Smith (2019) andInoue and Rossi (2019) show, using completely different methodologies, that the response of the economy to forward guidance shock is indeed consistent with standard predictions from New Keynesian models.…”

Understanding the Aspects of Federal Reserve Forward Guidance

“…Lucca and Trebbi (2009) and Rosa (2011) classify the semantic orientation or tone of FOMC statements, which indicates whether the federal funds rate will increase or decrease in the future. 4 Gertler and Karadi (2015), Bundick and Smith (2016), Miranda-Agrippino (2016), D'Amico and King (2017), Lakdawala (2017), and Jarociński and Karadi (2018) are part of a related literature that uses structural vector autoregressions. Rosa and Verga (2008) and Andrade and Ferroni (2016) study European monetary policy communication.…”

“…Krugman (1998) is a seminal paper in this literature. More recent papers in this literature areLevin et al (2010),Laséen and Svensson (2011), Werning (2011), Campbell et al (2012,Milani and Treadwell (2012),Carlstrom, Fuerst, and Paustian (2015),Del Negro, Giannoni, and Patterson (2015),Bundick and Smith (2016),Campbell et al (2016), and McKay,Nakamura, and Steinsson (2016).2Ellingsen and Söderström (2001),Frankel and Katrik (2015),Tang (2015),Gaballo (2016),Melosi (2017),Andrade et al (2018),Jarociński and Karadi (2018), and Jia (2018) also provide models where central bank policy reveals private information or coordinates dispersed information.…”

The European Central Bank's Monetary Policy during Its First 20 Years

“…The results of this exercise are also shown in figure 24, which compares changes in the shadow rate (the dashed line) with the outcome of the Orphanides rule (the dotted line) after the DFR reached 74. See Bundick and Smith (2016); Swanson (2017); and Inoue and Rossi (2018). 0 percent in July 2012.…”