Forward Guidance and the State of the Economy

40 Pages Posted: 10 Nov 2016  

Benjamin D. Keen

University of Oklahoma - Department of Economics

Alexander W. Richter

Federal Reserve Bank of Dallas

Nathaniel A. Throckmorton

College of William and Mary

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-11-08

Abstract

This paper examines forward guidance using a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule. The effectiveness of forward guidance depends on the state of the economy, the speed of the recovery, the ZLB constraint, the degree of uncertainty, the monetary response to inflation, the size of the news shocks, and the forward guidance horizon. Specifically, the stimulus from forward guidance falls as the economy deteriorates or as households expect a slower recovery. When the ZLB binds, less uncertainty about the economy or an expectation of a stronger response to inflation reduces the benefit of forward guidance. Forward guidance via a news shock is less stimulative than an unanticipated monetary policy shock around the steady state, but a news shock is more stimulative near the ZLB and always has a larger cumulative effect on output. When the central bank extends the forward guidance horizon, the cumulative effect initially increases but then decreases. These results indicate that there are limits to the stimulus forward guidance can provide, but that stimulus is largest when the news is communicated early in a recession.

Keywords: Forward guidance, zero lower bound, news shocks, global solution method

JEL Classification: E43, E58, E61

Suggested Citation

Keen, Benjamin D. and Richter, Alexander W. and Throckmorton, Nathaniel A., Forward Guidance and the State of the Economy (2016-11-08). FRB of Dallas Working Paper No. 1612. Available at SSRN: https://ssrn.com/abstract=2866847 or http://dx.doi.org/10.24149/wp1612

Benjamin D. Keen (Contact Author)

University of Oklahoma - Department of Economics ( email )

729 Elm Avenue
Norman, OK 73019-2103
United States

Alexander W. Richter

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5360 (Phone)

HOME PAGE: http://alexrichterecon.com

Nathaniel A. Throckmorton

College of William and Mary ( email )

P.O. Box 8795
Williamsburg, VA 23187
United States

HOME PAGE: http://nathrockmorton.people.wm.edu/

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