Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy

45 Pages Posted: 23 Jul 2018 Last revised: 21 Feb 2019

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Ryota Ogaki

University of Tokyo

Sebastian Schmidt

European Central Bank (ECB)

Paul Yoo

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School

Multiple version iconThere are 2 versions of this paper

Date Written: 2018-07-19

Abstract

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: Discounted euler equation, Discounted phillips curve, Effective lower bound, Forward guidance, Optimal policy

JEL Classification: E52, E58, E61

Suggested Citation

Nakata, Taisuke and Ogaki, Ryota and Schmidt, Sebastian and Yoo, Paul, Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy (2018-07-19). FEDS Working Paper No. 2018-049. Available at SSRN: https://ssrn.com/abstract=3217785 or http://dx.doi.org/10.17016/FEDS.2018.049

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Ryota Ogaki

University of Tokyo ( email )

Yayoi 1-1-1
Bunkyo-ku
Tokyo, 113-8657
Japan

Sebastian Schmidt

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Paul Yoo

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States

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