Forward Guidance without Common Knowledge*

What are the effects of forward guidance or, more generally, of news about the future? Workhorse macroeconomic models answer this question by imposing a strong form of common knowledge: every agent is, not only aware of, or attentive to, the news, but also confident that everyone is aware, that everyone is confident that everyone is aware, and so on. Once this assumption is relaxed, expectations of future outcomes become less responsive, especially to news regarding more distant events, effectively leading to heavier discounting of the future. By the same token, general-equilibrium mechanisms that hinge on forward-looking expectations, such as the feedback loop between inflation and spending, are attenuated. We establish these insights within a class of games (“dynamic beauty contests”) which nest the New-Keynesian model along with other applications. We next show how these insights help resolve the forward-guidance puzzle and offer a rationale for the front-loading of fiscal stimuli.