Fiscal forward guidance: A case for selective transparency

Abstract

Should the fiscal authority use forward guidance to reduce future policy uncertainty per- ceived by private agents? Using dynamic general equilibrium models, we examine the wel- fare effects of announcing future fiscal policy shocks and show that selective transparency is desirable — announcing distortionary future policy shocks can be detrimental to ex ante social welfare, whereas announcing non-distortionary shocks generally improves welfare. Sizable welfare gains are found with constructive ambiguity regarding the timing of a tax increase in a realistic fiscal consolidation scenario. However, being secretive about distor- tionary shocks is time inconsistent, and welfare loss from communication may be unavoid- able. Show more