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Title: Taylor Rules and Forward Guidance: A Rule is not a Path

Author(s): Lilia Maliar and John B. Taylor

Publication Date: December 2018

Keyword(s): forward guidance and New Keynesian Model

Programme Area(s): Monetary Economics and Fluctuations

Abstract: We study the impact of forward guidance--non-systematic announcements about future policy rates -- in a stylized new Keynesian model. Using novel closed-form solutions, we show that the impact of forward guidance depends critically on the systematic monetary policy rule, ranging from non-existing to unrealistically large, the so-called forward guidance puzzle. We demonstrate that the puzzle occurs only under relatively passive -- empirically implausible and socially suboptimal -- policy rules, while more active empirically-relevant Taylor rules lead to sensible implications. Our analysis encompasses the case of a fixed interest-rate path, which characterizes effective lower-bound (ELB) periods. We conclude that it is not ELB per se that produces backward explosion but the passivity of monetary policy rules.

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Bibliographic Reference

Maliar, L and Taylor, J. 2018. 'Taylor Rules and Forward Guidance: A Rule is not a Path'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13383