We examine forward guidance from the standard New Keynesian economy's Ramsey problem. It makes two instruments available: the path of current and future interest rates, and an “open mouth operation" which selects from the many equilibria consistent with the chosen interest rates. Removing the open mouth operation by imposing a finite commitment horizon yields policy advice that relies on the forward guidance puzzle. Removing it by altering the private sector's forward-looking behavior requires empirically-implausible separation of asset prices from future economic outcomes. Requiring all agents to follow Markovian strategies can yield an empirically-plausible NK economy without effective open mouth operations.
Working Papers,
No. 2018-03,
2018
Open Mouth Operations (REVISED January 2019)