Federal Reserve Board
International Journal of Central Banking
This paper investigates the eﬀectiveness of central bank forward guidance while relaxing two standard macroeconomic assumptions: rational expectations and frictionless ﬁnancial markets. The results show that the addition of ﬁnancial frictions ampliﬁes the diﬀerences between rational expectations and adaptive learning to forward guidance. During a period of economic crisis, output under rational expectations displays more favorable responses to forward guidance than under adaptive learning. These diﬀerences are exacerbated when compared with a similar analysis without ﬁnancial frictions. Thus, monetary policymakers should consider the way in which expectations and credit frictions are modeled when examining the eﬀects of forward guidance.
Cole, Stephen J., "The Limits of Central Bank forward Guidance under Learning" (2020). Economics Faculty Research and Publications. 617.
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