The Power of Forward Guidance and the Fiscal Theory of the Price Level

Standard models predict implausible responses to forward guidance announcements when interest rates are pegged (the ``forward guidance puzzle"). This paper develops conditions for regime-switching models to exhibit a forward guidance puzzle, and shows when the fiscal theory of the price level does-- and does not --resolve the forward guidance puzzle. Forward guidance has reasonable effects when real fiscal revenues are very unresponsive to government debt, but in some empirically relevant cases, inflation must ensure debt stability and forward guidance puzzles are still there. Cyclical variation in deficits also affects the power of forward guidance