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A TV vox pop has gone viral after the host didn't bargain for interviewing a well-informed member of the public.Vox pop interviews are often known for selecting people with uninformed or uncommunicative answers.Textbook New Keynesian models deliver unreasonably large macroeconomic responses to forward guidance promises, a phenomenon described as the ‘forward guidance puzzle’ by Del Negro et al. To illustrate the puzzle, we draw on analysis from our recent paper (Haberis et al. We use a textbook model of the output gap, inflation, and the policy rate in which expectations about the future play a large role in households’ and firms’ decision making.Policy is set optimally under discretion – the policy rate is set to minimise welfare costs arising from (current and future) deviations of output from potential and inflation from target.As a result, forward guidance promises are much less powerful than standard analysis suggests.The term ‘forward guidance’ describes central bank communications about the likely future path of policy rates.Figure 1 Effects of fully credible forward guidance policies : The model starts in its steady state and is hit by a large recessionary shock.
Figure 1 shows the results, under the standard assumption that the promises are fully credible.And one Twitter user joked that he could imagine what the newsroom thought of their interviewee: 'That man is not helping us sow fear in order to boost ratings. In New Keynesian models, a promise to hold interest rates lower in the future has powerful effects on economic activity and inflation today.At the time of the announcement, this cost appears worth paying because the recession is smaller.As time passes, however, the benefits of the smaller recession become history, leaving only the cost of the overshoot.
The solid black lines show the baseline scenario, in which the policy rate is constrained at the ZLB for 7 quarters following the shock.