Forward Guidance without Common Knowledge

How does the economy respond to news about future policies or future fundamentals? Standard practice assumes that agents have common knowledge of such news and face no uncertainty about how others will respond. Relaxing this assumption attenuates the general equilibrium effects of news and rationali...

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Bibliographic Details
Published inThe American economic review Vol. 108; no. 9; pp. 2477 - 2512
Main Authors Angeletos, George-Marios, Lian, Chen
Format Journal Article
LanguageEnglish
Published Nashville American Economic Association 01.09.2018
Subjects
Economic policy
Economic theory
Game theory
Games
Keynesian theory
Myopia
News
Uncertainty
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Summary:How does the economy respond to news about future policies or future fundamentals? Standard practice assumes that agents have common knowledge of such news and face no uncertainty about how others will respond. Relaxing this assumption attenuates the general equilibrium effects of news and rationalizes a form of myopia at the aggregate level. We establish these insights within a class of games which nests, but is not limited to, the New Keynesian model. Our results help resolve the forward-guidance puzzle, offer a rationale for the front-loading of fiscal stimuli, and illustrate more broadly the fragility of predictions that rest on long series of forward-looking feedback loops.
ISSN:0002-8282
1944-7981
DOI:10.1257/aer.20161996