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