Versatile Forward Guidance: Escaping or Switching?

63 Pages Posted: 8 Jan 2018

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)

Yulin Liu

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

Martin Tischhauser

ETH Zurich

Date Written: January 2018

Abstract

We examine how forward guidance should be designed when an economy faces negative natural real interest-rate shocks and subsequent supply shocks. Besides a standard approach for forward guidance, we introduce two flexible designs: escaping and switching. With escaping forward guidance, the central banker commits to low interest rates in the presence of negative natural real interest-rate shocks, contingent on a self-chosen inflation rate threshold. With switching forward guidance, the central banker can switch from interest-rate forecasts to inflation forecasts any time in order to stabilize supply shocks. We show that for small and large natural real interest-rate shocks, escaping forward guidance is preferable to any of the other approaches, while switching forward guidance is optimal for intermediate natural real interest-rate shocks. Furthermore, with the polynomial chaos expansion method, we show that our findings are globally robust to parameter uncertainty. In addition, using Sobol' Indices, we identify the structural parameters with the greatest effect on the results.

Keywords: central banks, forward guidance, global robustness, polynomial chaos expansion, Sobol' Indices, transparency, zero lower bound

JEL Classification: E31, E49, E52, E58

Suggested Citation

Gersbach, Hans and Liu, Yulin and Tischhauser, Martin, Versatile Forward Guidance: Escaping or Switching? (January 2018). CEPR Discussion Paper No. DP12559. Available at SSRN: https://ssrn.com/abstract=3098135

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

Yulin Liu

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

Zürichbergstrasse 18
Zurich, 8092
Switzerland

Martin Tischhauser

ETH Zurich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

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