Make-up strategies with finite planning horizons but infinitely forward-looking asset prices

Abstract

How effective are forward-guidance and make-up strategies? Standard models find them extremely effective, but by assuming households’ inflation expectations respond much more strongly than in the data. Models where households discount the future find them much less effective and match the small reaction of inflation expectations, but not the actual large reaction of asset prices. We build a model that rationalizes both. Households cognitively discount the future, but more forward-looking financial market professionals incorporate their expectations of future policy into the long-term nominal rates faced by all. We find that make-up strategies have sizably better stabilization properties than inflation targeting.