The Dynamic Effects of Forward Guidance Shocks

36 Pages Posted: 22 Jan 2016 Last revised: 23 Dec 2016

Brent Bundick

Federal Reserve Bank of Kansas City

Andrew Lee Smith

Federal Reserve Bank of Kansas City

Date Written: December 2016

Abstract

We examine the macroeconomic effects of forward guidance shocks at the zero lower bound. Empirically, we identify forward guidance shocks using unexpected changes in futures contracts around monetary policy announcements. We then embed these policy shocks into a standard vector auto regression to trace out their macroeconomic implications. Forward guidance shocks that lower expected future policy rates lead to significant increases in economic activity and inflation. After examining forward guidance shocks in the data, we show that a standard model of nominal price rigidity can reproduce our empirical findings. To estimate our theoretical model, we generate a model-implied futures curve which closely links our model with the data. Our results suggest no disconnect between the empirical effects of forward guidance shocks and the predictions from a simple theoretical model.

Keywords: Forward Guidance, Federal Funds Futures, Zero Lower Bound, Impulse Response Matching

JEL Classification: E32, E52

Suggested Citation

Bundick, Brent and Smith, Andrew Lee, The Dynamic Effects of Forward Guidance Shocks (December 2016). Federal Reserve Bank of Kansas City Working Paper No. 16-02. Available at SSRN: https://ssrn.com/abstract=2720427

Brent Bundick (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Andrew Lee Smith

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

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