BPEA | Spring 2012

Macroeconomic Effects of FOMC Forward Guidance

Chalres L. Evans,
Chalres L. Evans Federal Reserve Bank of Chicago
Jonas D.M. Fisher,
Jonas D.M. Fisher Federal Reserve Bank of Chicago
Alejandro Justiniano, and
Alejandro Justiniano Federal Reserve Bank of Chicago
Jeffrey Campbell
Jeffrey Campbell headshot
Jeffrey Campbell Professor - University of Notre Dame and Tilburg University
Discussants: Michael Woodford and Charles Calomiris
Charles Calomiris Henry Kaufman Professor of Financial Institutions - Columbia University

Spring 2012

A large output gap accompanied by stable inflation close to its
target calls for further monetary accommodation, but the zero lower bound
on interest rates has robbed the Federal Open Market Committee (FOMC) of
the usual tool for its provision. We examine how public statements of FOMC
intentions—forward guidance—can substitute for lower rates at the zero bound.
We distinguish between Odyssean forward guidance, which publicly commits
the FOMC to a future action, and Delphic forward guidance, which merely
forecasts macroeconomic performance and likely monetary policy actions.
Others have shown how forward guidance that commits the central bank to
keeping rates at zero for longer than conditions would otherwise warrant can
provide monetary easing, if the public trusts it. We empirically characterize
the responses of asset prices and private macroeconomic forecasts to FOMC
forward guidance, both before and since the recent financial crisis. Our results
show that the FOMC has extensive experience successfully telegraphing its
intended adjustments to evolving conditions, so communication difficulties do
not present an insurmountable barrier to Odyssean forward guidance. Using
an estimated dynamic stochastic general equilibrium model, we investigate
how pairing such guidance with bright-line rules for launching rate increases
can mitigate risks to the Federal Reserve’s price stability mandate.