The Forward Guidance Puzzle
Marco Del Negro, Marc Giannoni
Federal Reserve Bank of New York
Christina Patterson
MIT
Penn State University, February 24, 2016
Disclaimer: The views expressed here do not necessarily reflect those of
the Federal Reserve Bank of New York or the Federal Reserve System
Introduction
Forward Guidance
• Announcements about future interest rate changes: key instrument
of monetary policy at least since 2008 (also before – see Campbell et
al. 2012)
1
What are the effects of forward guidance?
•
•
2
On financial markets
On expectations – Evidence from Blue Chip surveys
Can its effects be captured by standard medium-scale DSGE
models? No!
⇒ Forward Guidance Puzzle: Excessive response of output and
inflation
• The farther into the future is the change in FFR, the stronger
the economy’s response
3
A proposed resolution to the FG puzzle
•
Accounting for finite life: Blanchard-Yaari’s perpetual youth in
a medium-scale DSGE model
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Introduction
Transmission of Monetary Policy
• Pre-Great Recession
•
Key instrument of policy: short-term interest rate
•
Monetary transmission well understood (extensively studied
using both VAR models and DSGE models)
• Post-Great Recession
•
“New” policy tools: Forward guidance (FG), LSAPs
•
Goal at ZLB: lower long-term bond yields
−→ stimulate aggregate expenditures
•
But ... effects not well understood; harder to quantify using
existing empirical tools (e.g. VARs)
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Introduction
Analyzing the Effects of Forward Guidance – The Challenge
• Announcement by CB that will maintain FFR at ZLB for longer can
have two effects
(Campbell, Evans, Fisher, Justiniano 2012; Woodford 2012):
1
More monetary stimulus (Odyssean/Commitment a la
Eggertsson and Woodford 2003) −→ stimulates economic
activity, higher inflation
2
Reveals bad news about state of economy (Delphic) −→ lower
projected activity, lower inflation
• Interpretation by market depends in very subtle ways on FOMC
communication
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Introduction
Analyzing the Effects of Forward Guidance – The Challenge
• Like Odysseus, central bank commits to keeping FFR low despite
temptation to raise FFR once the economy is recovering
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Introduction
Analyzing the Effects of Forward Guidance – The Challenge
• Announcement by CB that will maintain FFR at ZLB for longer can
have two effects
(Campbell, Evans, Fisher, Justiniano 2012; Woodford 2012):
1
More monetary stimulus (Odyssean/Commitment a la
Eggertsson and Woodford 2003) −→ stimulates economic
activity, higher inflation
2
Reveals bad news about state of economy (Delphic) −→ lower
projected activity, lower inflation
• Interpretation by market depends in very subtle ways on FOMC
communication
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Introduction
Analyzing the Effects of Forward Guidance – The Challenge
• Like the Oracle of Delphi, central bank announces a low forecast for
FFR, given its forecast of weak economic conditions
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4
Introduction
Analyzing the Effects of Forward Guidance – The Challenge
• Announcement by CB that will maintain FFR at ZLB for longer can
have two effects
(Campbell, Evans, Fisher, Justiniano 2012; Woodford 2012):
1
More monetary stimulus (Odyssean/Commitment a la
Eggertsson and Woodford 2003) −→ stimulates economic
activity, higher inflation
2
Reveals bad news about state of economy (Delphic) −→ lower
projected activity, lower inflation
• Interpretation by market depends in very subtle ways on FOMC
communication
Del Negro, Giannoni, Patterson
Forward Guidance Puzzle
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4
Introduction
DSGE Models Suited to Analyze Forward Guidance?
• Medium-scale New Keynesian DSGE models “fit data well”
• Models are ”structural” −→ in principle well suited to perform
counterfactual experiments
• Problem: Model-implied response to FG much larger than observed
−→ ”Forward Guidance Puzzle”!
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Introduction
DSGE Models Suited to Analyze Forward Guidance?
• Medium-scale New Keynesian DSGE models “fit data well”
• Models are ”structural” −→ in principle well suited to perform
counterfactual experiments
• Problem: Model-implied response to FG much larger than observed
−→ ”Forward Guidance Puzzle”!
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1 – Effects of Forward Guidance: Empirical evidence
Evidence from Blue Chip Financial Forecasters
• Compute change in forecasts in a one-month window around the
announcement
• ... controlling for:
• all macro economic news (surprises)
• asset price movements (ex event window)
• Panel regression for variable (k), horizon (h), forecaster (i):
∆f (k, h)t,i = γ0 + γ10 Macro news + γ20 Asset Price Changes
+γ30 i-specific control + β Announcement Dummy + i,t
for t = 2008.06, .., 2015.02
• Std errors corrected for correlation across i’s and heteroskedasticity
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1 – Effects of Forward Guidance: Empirical evidence
August 2011
“ ... exceptionally low levels of the FFR at least through mid-2013”
• Projections for 3-month rates and 10-year yields decline
Change in forecasts of financial variables in line with asset
response in two-day window
• Forecasters believe the FOMC announcement
•
3-Month TBill
10 Treasury
1
0.5
0.5
0
0
-0.5
-0.5
-1
-1.5
-1
0
1
2
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4
5
6
0
Forward Guidance Puzzle
1
2
3
4
5
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7
1 – Effects of Forward Guidance: Empirical evidence
Evidence from Financial Markets: Forward Rates
• Pre-FOMC: solid; post-FOMC: dashed
• FF fut. (purple); Eurodol. fut. (blue); Fwd rates from yield curve (red)
08/09/11
“at least
through mid-13”
Yield Curves -­‐ 8/9/2011 01/25/12
09/13/12
“at least
“ mid-15” “..after the
Curves -­‐ 1/25/2012 economy strengthens”
through Yield late-14”
Yield Curves -­‐ 9/13/20
4.0 5.0 4.5 3.0 3.5 2.5 4.0 3.0 3.5 Fi>ed Forward Yield (before) Fi>ed Forward Yield (aCer) 2.5 Yield (%) Yield (%) Fi>ed Forward Yield (aCer) Eurodollar Futures: Swap Basis Adjusted (before) 2.0 Eurodollar Futures: Swap Basis Adjusted (before) 1.5 Eurodollar Futures: Swap Basis Adjusted (aCer) 2.0 1.5 Eurodollar Futures: Swap Basis Adjusted (aCer) Fed Funds Futures (before) 1.5 Fed Funds Futures (before) 1.0 FF Futures Yield (aCer) 1.0 FF Futures Yield (aCer) 1.0 0.5 Del Negro, Giannoni, Patterson
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9-­‐Year 8-­‐Year 7-­‐Year 6-­‐Year 5-­‐Year 3-­‐Year 4-­‐Year 2-­‐Year 10-­‐Year 1-­‐Year 0.0 9-­‐Year 8-­‐Year 7-­‐Year 6-­‐Year 5-­‐Year 3-­‐Year 4-­‐Year 2-­‐Year 1-­‐Year 0.0 9-­‐Year 8-­‐Year 6-­‐Year 7-­‐Year 5-­‐Year 3-­‐Year 4-­‐Year 2-­‐Year 0.0 10-­‐Year 0.5 0.5 1-­‐Year Yield (%) Fi>ed Forward Yield (before) 2.0 2.5 3.0 8
1 – Effects of Forward Guidance: Empirical evidence
Evidence from Financial Markets
• As in KVJ (11): look at cross-section of financial markets data
• Femia et al. 2013, Raskin 2013, Filardo and Hoffman 2014, Moessner 2013,...
Changes in bond yields in 2-day following FOMC meeting
Treasury Yields
Agency Yields
(constant maturity)
(Fannie/Freddie)
MBS
Yields
30
15
Maturity
(years)
30
10
5
3
1
30
10
5
3
8/9/2011
-14
-23
-18
-12
-3
-19
-23
-27
-25
-24
-26
1/25/2012
-5
-12
-15
-8
0
-10
-13
-18
-14
-16
-18
9/13/2012
17
11
2
2
0
10
5
0
1
-13
-11
Notes: All figures are in basis points unless otherwise noted.
• Bond yields fall in Aug. 2011 and Jan. 2012; increase in Sept. 2012
• Fed announcements affect yields:
• Hard to reconcile with lack of credibility story
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1 – Effects of Forward Guidance: Empirical evidence
August 2011
“... economic growth so far this year has been considerably slower than ...
expected. ...The Committee now expects a somewhat slower pace of recovery
over coming quarters ... economic conditions ... are likely to warrant
exceptionally low levels of the FFR at least through mid-2013”
GDP Growth
CPI Inflation
2
2.5
1.5
2
1
1.5
0.5
1
0
0.5
-0.5
0
-1
-0.5
-1.5
-2
-1
0
1
2
3
4
5
6
0
1
2
3
4
5
6
• Possible example of Delphic forward guidance: bad news about the
economy
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1 – Effects of Forward Guidance: Empirical evidence
September 2012
• ... “highly accommodative stance ... will remain appropriate for a
considerable time after the economic recovery strengthens. ... at
least through mid-2015”
GDP Growth
CPI Inflation
2
2.5
1.5
2
1
1.5
0.5
1
0
0.5
-0.5
0
-1
-0.5
-1.5
-2
-1
0
1
2
3
4
5
6
0
1
2
3
4
5
6
• Odyssean: significant increase in forecasts for real activity and
inflation
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1 – Effects of Forward Guidance: Empirical evidence
Evidence from Financial Markets
TIPS
Implied
Vol.
(constant maturity)
SP
500
DJ
IA
FX
USD/EUR
Maturity
(years)
30
20
10
7
5
8/9/2011
-26
-16
-33
-52
-39
-8.11
0.12
-0.83
-0.01
1/25/2012
-8
-11
-15
-18
-20
-4.21
0.29
0.46
0.56
9/13/2012
-9
-8
-15
-19
-25
-1.13
2.03
1.95
1.78
(% change)
(% change)
Notes: All figures are in basis points unless otherwise noted.
• Real rates fall
• Stocks prices: modest changes in Aug. 2011 and Jan. 2012; larger
increases in Sept. 2012
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1 – Effects of Forward Guidance: Empirical evidence
Breakevens
20 10
5
30
8/9/2011
-7
10
21
8
9
14
13
-3
16
4
-8
1/25/2012
3
3
5
3
3
4
8
12
0
1
3
9/13/2012
24
26
27
26
27
21
28
23
3
-5
1
Maturity
(years)
Inflation Swaps
20 10
5
1
Liquidity Premium
20 10
5
Notes: All figures are in basis points unless otherwise noted.
• Inflation breakeven and Inflation swaps increase especially in Sept.
2012
• Little variation in liquidity premium (TIPS-Treasury spread,
Fleckenstein et al.)
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1 – Effects of Forward Guidance: Empirical evidence
Corporate Yields
Intermediate term
Long term
Aaa
Aa
A
Baa
Ba
B
Aaa
Aa
A
Baa
Ba
B
8/9/2011
-8
-6
-8
-8
2
16
-11
-9
-5
-5
26
33
1/25/2012
-10
-13
-11
-16
-9
-13
-12
-15
-17
-13
-16
-10
9/13/2012
11
10
7
-2
-8
-15
0
-1
-1
5
-12
-18
Notes: All figures are in basis points unless otherwise noted.
• While high-grade yields decrease in August 2011 in line with
Treasuries, low-grade corporate yields increase (safety premium ↑)
• Low-grade corporate yields fall in Sept 2012 (safety premium ↓)
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1 – Effects of Forward Guidance: Empirical evidence
Evidence from Financial Markets
• August 2011:
• Bond yields and real rates fall; little change in stocks prices
• Inflation breakeven and inflation swaps increase slightly
• January 2012:
• Financial market response similar to that of August 2011, but more
modest
• September 2012: Different response
• Real yields fall
• But bond yields rise with inflation breakeven and inflation swaps;
stock market rises
• Sept. 2012: Could be consistent with Odyssean forward guidance:
monetary policy more accommodative than expected and provides
more stimulus
• ... “highly accommodative stance of monetary policy will remain appropriate for a
considerable time after the economic recovery strengthens”.
• What happened to output forecasts?
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1 – Effects of Forward Guidance: Empirical evidence
Effect of Different Aspects of the FOMC Statement
• Add dummies for announcements of:
•
Forward guidance episode
•
QE
•
Continuation of QE
•
Output conditions
•
Inflation conditions
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1 – Effects of Forward Guidance: Empirical evidence
Effect of Different Aspects of the FOMC Statement
Forward Guidance
QE Announcement
Bad Output Language
GDP Growth
1
1
0.8
0.8
0.8
0.6
0.6
0.6
0.4
0.4
0.4
0.2
0.2
0.2
0
0
0
-0.2
-0.2
-0.2
-0.4
-0.4
-0.4
-0.6
-0.6
-0.6
-0.8
-0.8
-1
1
-0.8
-1
0
1
2
3
4
-1
0
1
2
3
3-Month TBill
4
0
1
2
3
4
-0.5
4
0
1
2
3
4
0.5
0.5
0.4
0.4
0.4
0.3
0.3
0.3
0.2
0.2
0.2
0.1
0.1
0.1
0
0
0
-0.1
-0.1
-0.1
-0.2
-0.2
-0.2
-0.3
-0.3
-0.3
-0.4
-0.4
-0.5
0
1
2
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3
-0.5
4
0
0.5
-0.4
1
2
3
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2 – Forward Guidance in DSGE Models
The Forward Guidance Puzzle
• Medium-scale DSGE – Good forecasting performance
• In principle well suited for counterfactual experiments
• 2012Q2 “experiment”: FFR kept at ZLB through 2015Q2
See also Carlstrom et al. 2012
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2 – Forward Guidance in DSGE Models
The Two Legs of the Forward Guidance Puzzle
1: Consumption depends on the expected future short-term real rates:
ĉt = −IE t [R̂t − π̂t+1 + ĉt+1 ] =⇒ ĉt = −
∞
X
j=0
IE t [R̂t+j − π̂t+1+j ]
|
{z
}
r̂t+j
• Contemporaneous shock: r̂t ↓ ⇒ ĉt ↑, ĉt+1 = 0, ...
• Anticipated shock:
r̂t+H ↓ ⇒ ĉt ↑, ĉt+1 ↑, ..., ĉt+H ↑
• The farther the rate drop, the longer does consumption boom last
(McKay, Nakamura, Steinsson, 2015)
2: Now let π move. NK Phllips curve implies
π̂t = κ
∞
X
β j IE t [ĉt+j ]
j=0
• Anticipated shock: more prolonged consumption boom
=⇒ π̂t , π̂t+1 , ... rises more =⇒ real rate drops even more today
=⇒ consumption increase amplified
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2 – Forward Guidance in DSGE Models
The Two Legs of the Forward Guidance Puzzle
1: Consumption depends on the expected future short-term real rates:
ĉt = −IE t [R̂t − π̂t+1 + ĉt+1 ] =⇒ ĉt = −
∞
X
j=0
IE t [R̂t+j − π̂t+1+j ]
|
{z
}
r̂t+j
• Contemporaneous shock: r̂t ↓ ⇒ ĉt ↑, ĉt+1 = 0, ...
• Anticipated shock:
r̂t+H ↓ ⇒ ĉt ↑, ĉt+1 ↑, ..., ĉt+H ↑
• The farther the rate drop, the longer does consumption boom last
(McKay, Nakamura, Steinsson, 2015)
2: Now let π move. NK Phllips curve implies
π̂t = κ
∞
X
β j IE t [ĉt+j ]
j=0
• Anticipated shock: more prolonged consumption boom
=⇒ π̂t , π̂t+1 , ... rises more =⇒ real rate drops even more today
=⇒ consumption increase amplified
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2 – Forward Guidance in DSGE Models
Possible Resolutions
1
The Euler equation?
• McKay, Nakamura, Steinsson (2015), Caballero and Fahri (2014)
• Here: Discounting in the Euler equation coming from overlapping
generations
• Werning (2015)
2
The NKPC?
• Kiley et al. 2014, Carlstrom et al. 2012
3
Lack of credibility?
• At odds with surveys and financial markets responses
4
Deviations from rational expectations?
• Gabaix (2015), Garcia-Schmidt, Woodford (2015)
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3 – A Proposed Resolution
A Proposed Resolution: Finite Life (Blanchard-Yaari)
• Agents face probability p of “dying”
∞
X
(β(1 − p))s log(Cj,t+s )
s=0
• Life-insurance companies offer an annuity contract → individual
wealth accumulates at R/(1 − p)
Sj,t+1 =
Rt
(Sj,t + Yt − Cj,t )
1−p
• Individual EE for each cohort j:
Cj,t+1 = βRt Cj,t ⇒ Cj,t =
where Ht =
P∞
• Aggregate EE:
s=0
Qs−1
l=0
Yt+s
(Rt+l /(1−p))
Ct+1 = Rt βCt −
Del Negro, Giannoni, Patterson
(Sj,t + Ht )
1 − β(1 − p)
p(1 − β(1 − p))
St+1
(1 − p)
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3 – A Proposed Resolution
A Proposed Resolution: Finite Life (Blanchard-Yaari)
• Agents face probability p of “dying”
∞
X
(β(1 − p))s log(Cj,t+s )
s=0
• Life-insurance companies offer an annuity contract → individual
wealth accumulates at R/(1 − p)
Sj,t+1 =
Rt
(Sj,t + Yt − Cj,t )
1−p
• Individual EE for each cohort j:
Cj,t+1 = βRt Cj,t ⇒ Cj,t =
where Ht =
P∞
• Aggregate EE:
s=0
Qs−1
l=0
Yt+s
(Rt+l /(1−p))
Ct+1 = Rt βCt −
Del Negro, Giannoni, Patterson
(Sj,t + Ht )
1 − β(1 − p)
p(1 − β(1 − p))
St+1
(1 − p)
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-0.05
-0.05
W
3 – A Proposed Resolution
A Proposed Resolution: Finite Life (Blanchard-Yaari)
-0.1 probability: p = 0, p > 0
• -0.1
Announced future drop in R. ”Death”
Counsumption
0
10
20
30
0.01
0
20
30
10
20
30
×10 -3
10
0.005
10
5
0
0
-0.005
-0.01
0
10
20
30
-5
0
Individual Response
Aggregate Response
• Individuals: consumption ↑, wealth ↓ (standard Euler eq)
• But unborn cohorts cannot react to the announcement
• In the aggregate, C increases as it gets closer to drop in R
(as newborn cohorts react)
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3 – A Proposed Resolution
Smets-Wouters Model with Blanchard-Yaari Households
• Aggregate consumption Euler equation (simplified):
ĉt = − R̂t − IE t [π̂t+1 ] + (1 − η)IE t [ŝt+1 ] + ηIE t [ĉt+1 ]
where η < 1 when p > 0
• Evolution of wealth ŝt and fiscal policy
• All other equations are the same as in SW (with β̃ = ηβ),
e.g. NK Phillips Curve:
πt = Et
∞
X
β̃
j
κ mct+j
j=0
• SWBY: Tractable medium scale DSGE
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3 – A Proposed Resolution
Does it Matter Quantitatively?
• Calibration of p:
•
Average death prob. (Soc. Sec.) per quarter: 0.4% to 0.8%
•
In addition, can loosely think of p as the probability of
entering/exiting hand-to-mouth status (e.g. bankruptcy,.., from
Kaplan, Violante, Wieder 2014: 2.3%)
•
Baseline: p = 3%; alternative: p = 6%
• All other parameters taken from Smets and Wouters
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3 – A Proposed Resolution
Contemporaneous drop in FFR
• Response to contemporaneous shock similar for p = 0, 3% or 6%
Horizon 0
Interest rate (% annualized)
Inflation (% annualized)
0.1
0.07
p = 0, η = 1
p = 0.03, η = 0.987
p = 0.06, η = 0.96
0.05
0
0.06
0.05
−0.05
0.04
−0.1
0.03
−0.15
0.02
−0.2
0.01
−0.25
0
5
10
15
0
0
Consumption (level, %)
10
15
Output (level, %)
0.14
0.14
0.12
0.12
0.1
0.1
0.08
0.08
0.06
0.06
0.04
0.04
0.02
0
5
0.02
0
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5
10
15
0
Forward Guidance Puzzle
0
5
10
15
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3 – A Proposed Resolution
Announcement of FFR drop in 8 quarters
Horizon 8
Interest rate (% annualized)
Inflation (% annualized)
1
5
p = 0, η = 1
p = 0.03, η = 0.987
p = 0.06, η = 0.96
0.8
0.6
4
0.4
3
0.2
2
0
1
−0.2
−0.4
0
5
10
15
0
0
Consumption (level, %)
5
10
15
Output (level, %)
6
8
5
6
4
3
4
2
2
1
0
0
5
10
15
0
0
5
10
15
• With p = 0: FG causes huge changes in output and inflation
• With p = 3%, response of output and inflation cut by 2/3
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3 – A Proposed Resolution
Estimated Model
Horizon 4
Interest rate (% annualized)
Inflation (% annualized)
0.1
0.012
p
p
p
p
0.05
0
−0.05
=
=
=
=
0, η = 1
0.03, η = 0.99
0.06, η = 0.971
0.145, η = 0.899
0.01
0.008
0.006
−0.1
0.004
−0.15
0.002
−0.2
−0.25
0
5
10
15
0
0
Consumption (level, %)
5
10
15
Output (level, %)
0.4
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0
−0.1
0
5
10
15
0
0
5
10
15
• r∗ = 1/β̃ is fixed across simulations
• Very preliminary results!
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Conclusions
Conclusions
1
What are the effects of forward guidance?
•
Stimulative, non-trivial, but not huge
2
Can its effects be captured by standard medium-scale DSGE
models?
• No! Estimated DSGE model delivers implausibly large
responses to forward guidance
3
A proposed resolution to the forward guidance puzzle
• Blanchard-Yaari
• Compositional effects imply discounting in the Euler
equation =⇒ mitigate aggregate response
Del Negro, Giannoni, Patterson
Forward Guidance Puzzle
Penn State
28
Reference Slides
Reference Slides
Del Negro, Giannoni, Patterson
Forward Guidance Puzzle
Penn State
29
Reference Slides
September 2012
• ... “highly accommodative stance ... will remain appropriate for a
considerable time after the economic recovery strengthens. ...
exceptionally low levels for the FFR are likely to be warranted at
least through mid-2015”
3-Month TBill
10-Year Treasury
0.6
0.8
0.7
0.5
0.6
0.4
0.5
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0
0
−0.1
−0.1
0
1
2
3
4
5
6
−0.2
0
1
2
3
4
5
6
• Long term-rates increase (in line with market reaction)
Del Negro, Giannoni, Patterson
Forward Guidance Puzzle
Penn State
30
Fwd Guidance Puzzle and Effects of Changes in the
Reaction Function
• “Excessive” response of output and inflation as well
• Note: Nominal rates can ↑ in equilibrium following an announcement
about the reaction function (consistent with 9/13/12)
Federal Funds Rate
Ex−Ante Real Interest Rate
6
4
5
2
4
0
3
−2
2
−4
1
Inertial Taylor 99
Baseline Forecast
0
2014
2015
2016
2017
2018
2019
2020
2021
Inertial Taylor 99
Baseline Forecast
−6
2014
Output Growth
2016
2017
2018
2019
2020
2021
Inflation (GDP Deflator, Q/Q Annualized)
12
7
Inertial Taylor 99
Baseline Forecast
10
5
6
4
4
3
2
2
0
Inertial Taylor 99
Baseline Forecast
6
8
−2
2014
2015
1
2015
2016
2017
2018
2019
2020
2021
0
2014
2015
2016
2017
2018
2019
2020
2021