Disciplining expectations and the forward guidance puzzle

Forward guidance operates via the expectations formation process of the agents in the economy. In standard quantitative macroeconomic models, expectations are unobserved variables formed endogenously via the dynamics of the model and little scrutiny is devoted to analysing the behaviour of these expectations. We show that the introduction of survey and financial market-based forecast data in the estimation of the model disciplines the ex-pectations formation process in DSGE models. When the model-implied expectations are matched to observed expectations, the additional information of the forecasts restrains the agents' expectations formation. We argue that the reduced volatility of the agents' expec-tations dampens the model reactions to forward guidance shocks and improves the out-of-sample forecast accuracy of the model. Furthermore, we evaluate the case for introducing a discount factor as a reduced form proxy for a variety of microfounded approaches, pro-posed to mitigate the forward guidance puzzle. Once data on expectations is considered, the empirical support to introduce a discount factor dissipates. (c) 2022 Elsevier B.V. All rights reserved.