However, these predictions are at odds with the effects actually observed in practice – a phenomenon that has been described as the “forward guidance puzzle.” 3 When considering this puzzle, two factors are important.
The first is that in standard macroeconomic models, there are no limits to consumption smoothing over time due to the large intertemporal elasticity of substitution and the absence of borrowing constraints. The second is that inflation expectations respond instantaneously to any change in policy.