Discussion paper

DP13383 Taylor Rules and Forward Guidance: A Rule is not a Path

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.


Taylor, J (2018), “DP13383 Taylor Rules and Forward Guidance: A Rule is not a Path”, CEPR Press Discussion Paper No. 13383. https://cepr.org/publications/dp13383