Norges Bank

Working Paper

Unpacking the forward guidance puzzle

Author:
SeHyoun Ahn
Series:
Working Paper
Number:
11/2023

Abstract

I prove that in any linearized general equilibrium model with existence and uniqueness of equilibrium, any present response to a future shock always becomes weaker the further away the shock is. There is no forward guidance puzzle in any sensible general equilibrium model if forward guidance is a one-time shock in the future. The difference from the literature arises from the underappreciated preceding peg of interest rate. The standard forward guidance exercise, of a drop in the interest rate in the future with the preceding peg of interest rate, is a series of explosive deviations disguised as a small, one-time shock in the future. I unpack the standard forward guidance exercise in different ways, and show that there is nothing puzzling about the forward guidance puzzle.

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ISSN 1502-8190 (online)

Published 30 August 2023 10:45
Published 30 August 2023 10:45