The anchoring of inflation expectations manifests in two testable predictions. First, expectations about inflation far in the future should no longer respond to news about current inflation. Second, better anchored inflation expectations weaken the relationship between unemployment and inflation, flattening the reduced-form Phillips curve. We evaluate both predictions and find that communication of a numerical inflation objective better anchored inflation expectations in the US but failed to anchor expectations in Japan. Moreover, the improved anchoring of US inflation expectations can account for much of the observed flattening of the Phillips curve. Finally, we present evidence that initial Federal Reserve communication around its longer-run inflation objective may have led inflation expectations to anchor at a level below 2 percent.

This paper studies the transmission of Federal Reserve communication to financial markets and the economy using new measures of the term structure of policy rate uncertainty. Movements in the term structure of interest rate uncertainty around FOMC announcements cannot be summarized by a single measure but instead are two dimensional. We characterize these two dimensions as the level and slope factors of the term structure of interest rate uncertainty. These two monetary policy uncertainty factors significantly help to explain changes in Treasury yields and forward real interest rates around FOMC announcements, even after accounting for changes in the expected path of policy rates. Moreover, we demonstrate that focusing on just a single dimension of monetary policy uncertainty provides an inaccurate description of how policy uncertainty shapes the transmission of FOMC announcements. Finally, our policy uncertainty factors provide stronger first-stage instruments in a proxy SVAR setting which implies more expansionary macroeconomic effects of forward guidance than those estimated only using the expected path of policy rates.

At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.   

Also available as NBER Working Paper 21838

Aggregate demand becomes upward sloping when the economy is stuck at the zero lower bound.  Thus, the economy may respond very differently to real shocks.  A positive technology shock which shifts aggregate supply downward can cause a large contraction in output.  However, these differential responses to shocks emerge when the central bank follows a standard Taylor rule (TR) subject to the zero lower bound.  This rule implies that the central bank stops responding to the state of the economy at the zero lower bound.  This assumption is inconsistent with the recent behavior by monetary policymakers.  The responses to shocks may not be so different if the central bank follows a history-dependent (HD) rule, which continues to respond the economy using expectations about future policy. 

We examine the macroeconomic effects of forward guidance shocks at the zero lower bound.  In the data, forward guidance shocks that lower the expected path of policy stimulate economic activity and prices (blue line).   A standard model of monetary policy (red line) can largely replicate the dynamic responses from the empirical evidence. Our results suggest no disconnect between the empirical effects of forward guidance shocks and the predictions from a standard model of monetary policy.       

The Review of Economics & Statistics, 2020, 102(5): 946-965. 

Additional Material:  Technical Appendix & Slides

An uncertainty shock in the data causes a contraction in output and its components.  A standard model of nominal price rigidity is fully consistent with this empirical evidence.  We calibrate changes in uncertainty using implied stock market volatility and find that increased uncertainty about the future may have played a significant role in worsening the Great Recession. 

Uncertainty about future interest rates fell after the FOMC began releasing its participants’ projections for the appropriate federal funds rate. In addition, changes in the participant disagreement help explain movements in uncertainty around FOMC meetings. 

The FOMC’s implicit monetary policy rule, as perceived by professional forecasters, is similar before and during the recent zero lower bound period.

We document changes in college tuition over time and attempt to explain the  long  rise and subsequent fall in college tuition  inflation.  Statistical evidence suggests  that wages in the education sector and  state appropriations to higher education  both play an important role in explaining changes in college tuition inflation.