Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy

We examine the implications of less powerful forward guidance for optimal policy using a sticky-price model with an eﬀective lower bound (ELB) on nominal interest rates as well as a discounted Euler equation and Phillips curve. When the private-sector agents discount future economic conditions more in making their decisions today, an announced cut in future interest rates becomes less eﬀective in stimulating current economic activity. While the implication of such discounting for optimal policy depends on its degree, we ﬁnd that, under a wide range of plausible degrees of discounting, it is optimal for the central bank to compensate for the reduced eﬀect of a future rate cut by keeping the policy rate at the ELB for longer.

Keywords: forward guidance, optimal policy, discounted euler equation, discounted phillips curve, eﬀective lower bound

JEL Classification: E52, E58, E61

Suggested Citation: Suggested Citation

Nakata, Taisuke and Ogaki, Ryota and Schmidt, Sebastian and Yoo, Paul, Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy (January 11, 2019). ECB Working Paper No. 2220, Kenan Institute of Private Enterprise Research Paper No. 19-5, Available at SSRN: https://ssrn.com/abstract=3315179 or http://dx.doi.org/10.2139/ssrn.3315179