THE FORWARD GUIDANCE PUZZLE
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1 DISCUSSION OF: THE FORWARD GUIDANCE PUZZLE BY DEL NEGRO, GIANNONI AND PATTERSON Jón Steinsson Columbia University October 25 Jon Steinsson Forward Guidance Puzzle October 25 / 2
2 THREE PARTS Empirical investigation of three forward guidance announcements Aug 2 ( mid-23 ), Jan 22 ( late 24 ), Sep 22 ( mid 25 ) Seek to control for Delphic component of shock Forward guidance in standard medium-scale DSGE model Effects on contemporaneous outcomes implausibly large Forward guidance puzzle Propose a resolution to the puzzle: Blandard-Yaari perpetual youth model Makes model less forward looking Jon Steinsson Forward Guidance Puzzle October 25 2 / 2
3 PART I The Tale of Three Forward Guidance Announcements
4 INFORMATION CONTENT OF ANNOUNCEMENTS Monetary announcements may convey information about: Future monetary policy News about future path of interest rates conditional on unchanged beliefs about other fundamentals Conventional view or Odyssean forward guidance Future path of fundamentals Evidence: Campell et al. 2, Nakamura-Steinsson 5 Delphic forward guidance Furthermore, different monetary announcements may contain a different mix Jon Steinsson Forward Guidance Puzzle October 25 3 / 2
5 4 2 Figure 2: The Effect of Forward Guidance Announcements on Expectations August 2 January 22 September 22 GDP Growth CPI Inflation Month TBill Jon Steinsson -.5 Forward Guidance Puzzle -.5 October 25 4 / 2
6 IDENTIFICATION ISSUE To estimate effects of pure forward guidance... (i.e., Odyssean part only)... must control for news about other fundamentals (i.e., Delphic part) and QE Jon Steinsson Forward Guidance Puzzle October 25 5 / 2
7 ISOLATE EFFECT OF NEWS ABOUT INTEREST RATES Same as before expect different characterization of policy: f it = β POLICY t + β 2 X it + ɛ it Policy includes: Dummy for forward guidance announcement Dummy for QE announcement Dummy for QE continuation announcement Measure of output language Measure of inflation language Jon Steinsson Forward Guidance Puzzle October 25 6 / 2
8 Figure 3: Decomposing FOMC Statements: The Effect of Forward Guidance, QE Announcements and Bad GDP Language Forward Guidance QE Announcement Bad Output Language GDP Growth CPI Inflation Month TBill Jon Steinsson -.2 Forward Guidance Puzzle -.2 October 25 7 / 2
9 MEASURING THE LANGUAGE Very innovative and interesting! Next steps: Unexpected versus expected language Unexpected versus expected QE More sophisticated measure of forward guidance Jon Steinsson Forward Guidance Puzzle October 25 8 / 2
10 PART II Forward Guidance in a Standard Medium-Scale DSGE Model
11 ESTABLISHING THE PUZZLE This section originally circulated in 22 among first papers to draw attention to immense power of forward guidance (see also Carlstrom, Furst, and Paustian, 22; Kiley, 22) Conduct policy experiments in FRBNY DSGE model Similar to Christiano-Eichenbaum-Evans 5, Smets-Wouters 7 Includes credit frictions as in Christiano-Motto-Rostagno 9 Policy experiment: Starting from baseline forecast about nominal rates (inferred from forwards) Hold nominal rate at 25bp until mid-25 Jon Steinsson Forward Guidance Puzzle October 25 9 / 2
12 ows the model s predictions conditional on alternative assumptions regarding the fed the historical data. The dashed red lines show the FRBNY DSGE model s baselin n the model s Jon Steinsson predictions in a counterfactual Forward Guidance Puzzle policy experiment inoctober which 25the federa / 2
13 Figure 4: The model-implied consequences of forward guidance Jon Steinsson Forward Guidance Puzzle October 25 / 2
14 Figure 5: Interest-rate projections farther into the future e figure shows the model s predictions for the federal funds rate farther into the future. The black solid line sh data. The dashed red line shows the FRBNY DSGE model s baseline forecast. The solid red line shows the s in a counterfactual policy experiment in which the federal funds rate is set to.25 percent until 25Q2. Jon Steinsson Forward Guidance Puzzle October 25 2 / 2
15 EFFECTS OF FORWARD GUIDANCE Very, very persistent fall in nominal rates -year yield falls more than 5-year yield!! How can this be? Jon Steinsson Forward Guidance Puzzle October 25 3 / 2
16 EFFECTS OF FORWARD GUIDANCE Forward guidance shock reveals: Huge response to far future changes in interest rates Model has very persistent oscillatory dynamics Oscillatory dynamics imply that small stimulus over quarters creates large recession five years later (not just FRBNY model also SW 7 model) Valuable insight about models we use!! Not a desirable feature?!? Jon Steinsson Forward Guidance Puzzle October 25 4 / 2
17 PART III The Puzzle Resolved
18 WHY DOES IT WORK? Shrinks coefficients on forward-looking terms in all equations Makes model less forward looking For example in the price Phillips curve (ignoring indexation): π t = βe t π t+ + κmc t where β = ηβ and η <. So, β < β. Jon Steinsson Forward Guidance Puzzle October 25 5 / 2
19 les are also discounted more heavily in the equations determining investment, on, and real wages. The slope of the Phillips curve κ is also affected, rising wit probability p. Table 2. Implied Coefficients for Alternative Death Probabilities Death probability p.3.6 Implied coefficients Discounting in consumption η Discounting in investment β/( + β) Discounting in price inflation β/( + ιp β) Discounting in real wage β/( + β) Slope of Phillips Curve κ s shown in Figure 8, increasing the death probability has little effect on the econo se to contemporaneous monetary shocks. This suggests that the model has stan ations in response to contemporaneous shocks. Jon Steinsson Forward Guidance Puzzle October 25 6 / 2
20 BUT ISN T THIS THE INTEREST RATE? The β in front of E t π t+ due to firm discounting of future profits. So, really, it is one-over the gross interest rate In the standard model ( + r) = β In the perpetual youth model (ignoring steady state inflation and growth) ( + r) = β = ηβ So, again, it is one-over the gross interest rate that shows up as coefficient on E t π t+ Jon Steinsson Forward Guidance Puzzle October 25 7 / 2
21 BUT ISN T THIS THE INTEREST RATE? Interest rate to calibrate to is the same no matter what p is β should be calibrated to match interest rate and not vary with p (β should vary with p to match interest rate) In this case, forward-lookingness of all equations except consumption Euler equation will be unaffected by perpetual youth stuff What is left is less forward-looking consumption Euler equation Jon Steinsson Forward Guidance Puzzle October 25 8 / 2
22 PDV of Labo Figure 7: Forward Guidance in a Blanchard-Yaari Model: Individual vs. Aggregate Response Wealth Counsumption Individual Response Aggregate Response Notes: The figure shows impulse response functions to an anticipated drop in interest rates quarters in the future. The red line shows the simulation with p =. and the blue line shows the impulse responses with p =.5. C j,t = Y. 38 Consider a forward guidance experiment where the path of the interest rate is temporarily reduced at some future date T (R T < R) but remains unchanged (R t = R) at all Jon Steinsson Forward Guidance Puzzle October 25 9 / 2 other dates. The left panel of Figure 7 shows the simulated impulse responses this future
23 CONCLUSION Very nice paper!! I could go on for an hour about it! Jon Steinsson Forward Guidance Puzzle October 25 2 / 2
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