Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy
45 Pages Posted: 23 Jul 2018 Last revised: 21 Feb 2019
Date Written: 2018-07-19
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: Suggested Citation