Unpacking the forward guidance puzzle
- Working Paper
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.
Norges Bank’s Working Papers present research projects and reports that are generally not in their final form. Other analyses by Norges Bank’s economists are also included in the series. The views and conclusions in these documents are those of the authors.
ISSN 1502-8143 (online)