Forward Guidance Contracts

47 Pages Posted: 9 Jun 2015

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Volker Hahn

University of Konstanz

Yulin Liu

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich

Date Written: May 31, 2015

Abstract

We examine “Forward Guidance Contracts”, which make central bankers’ utility contingent on the precision of interest-rate forecasts for some time. Such Forward Guidance Contracts are a flexible commitment device and can improve economic performance when the economy is stuck in a liquidity trap. Utilizing the New Keynesian Framework, we establish the properties of simple renewable Forward Guidance Contracts and characterize the contracts that the government wants to offer repeatedly. These contracts create favorable tradeoffs between the efficacy of forward guidance at the zero bound and the reduced flexibility in reacting to future events, when the zero bound on nominal interest rates constrains the central banks’ choice. We discuss how Forward Guidance Contracts can be used when there is uncertainty about natural real interest-rate shocks, a situation which typically calls for moderate incentive intensity. Finally we explore alternative contractual environments.

Keywords: forward guidance, zero lower bound, central banks, incentive contracts, transparency

JEL Classification: E310, E490, E520, E580

Suggested Citation

Gersbach, Hans and Hahn, Volker and Liu, Yulin, Forward Guidance Contracts (May 31, 2015). CESifo Working Paper Series No. 5375. Available at SSRN: https://ssrn.com/abstract=2615732

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Volker Hahn

University of Konstanz ( email )

Box 143
Konstanz, 78457
Germany

Yulin Liu

ETH Zürich - CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland

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