Odyssean forward guidance in normal times

Abstract

We present a systematic treatment of dynamic effects of Odyssean forward guidance – explicit announcements about future policy rates. We focus on normal times unlike the mainstream of the literature that focuses on episodes of an effective (zero) lower bound on nominal interest rates. We present novel closed-form solutions to both deterministic and stochastic versions of a stylized new Keynesian model with fully anticipated future shocks. We establish a theorem that delineates the parameter space into real and complex-root regions characterized by different characteristic roots. We formulate a simple recipe for testing the effectiveness of forward guidance: the size of the smallest root is a single sufficient statistics that determines whether or not forward guidance generates significant contemporaneous effects.