Elsevier

Journal of Monetary Economics

Volume 108, December 2019, Pages 87-92
Journal of Monetary Economics

Comment on “Forward guidance: Communication, commitment, or both?” by Marco Bassetto

https://doi.org/10.1016/j.jmoneco.2019.09.008Get rights and content

Highlights

  • Forward guidance can be cheap talk in an infinitely repeated game with the public.

  • Asymmetric information is necessary for cheap talk to be useful.

  • The central bank can build credibility over time to make cheap talk credible.

  • When to use forward guidance instead of general transparency remains unclear.

  • Adding a lower bound on interest rates does not change the main conclusions.

Section snippets

A brief historical perspective and some context

The problem of central banks’ time inconsistency has been recognized and studied at least since the beginning of the rational expectations revolution of the 1970s. Time inconsistency occurs when past decisions that were optimal at the time they were made are suboptimal from today’s perspective, creating an incentive to deviate from the past decisions. The seminal works of Kydland and Prescott (1977) and Barro and Gordon (1983) showed that if the central bank has an “inflationary bias,” then it

Contributions of Bassetto (2019)

Bassetto (2019) generalizes the model in Stein (1989) in two main dimensions. First, it considers an infinitely-repeated version of the game. Interestingly, Stein (1989) shies away from an infinite horizon because he deems it “implausible.” I am less concerned with infinite horizons not being literally true. To me, it is just a very fruitful modeling device. Second, Bassetto (2019) allows for an incredibly general form of asymmetric information and an equally general message space. In contrast

What type of communication is more natural?

Bassetto (2019) analyzes the case in which the central bank has private information about its objective. In the model, this means private information about the inflation target πt*. Bassetto (2019) states that: “[...] households have all the information about the underlying state of the economy that they need to make decisions, given government policy. While the government could report its underlying information that leads it to prefer πt*, this is more information than necessary: all they need

Considerations about the lower bound on interest rates

The introduction of the IS curve also brings to the fore issues related to the ELB, which are bypassed when the central bank picks inflation directly and the IS curve is omitted. Given that Bassetto (2019) uses ELB episodes as motivation to study forward guidance and central bank communication, it is perhaps initially surprising that the ELB is absent from the model. However, although some of the details may change, I do not see a high value in explicitly adding an IS equation and an ELB. The

First page preview

First page preview
Click to open first page preview

References (15)

  • R.J. Barro et al.

    A positive theory of monetary policy in a natural rate model

    J. Political Economy

    (1983)
  • M. Bassetto

    Forward guidance: communication, commitment, or both?

    J. Monet. Econ

    (2019)
  • C. Borio et al.

    Unconventional monetary policies: a re-appraisal

    Research Handbook on Central Banking

    (2018)
  • J.R. Campbell et al.

    Macroeconomic effects of federal reserve forward guidance

    Brookings Pap. Econ. Act.

    (2012)
  • Y. Chen et al.

    Selecting cheap-talk equilibria

    Econometrica

    (2008)
  • R. Clarida et al.

    The science of monetary policy: a new keynesian perspective

    J. Econ. Lit.

    (1999)
  • A. Cukierman

    Central Bank Strategy, Credibility, and Independence: Theory and Evidence

    (1992)
There are more references available in the full text version of this article.

Cited by (0)

View full text