Forward Guidance and the Role of Central Bank Credibility under Heterogeneous Beliefs

56 Pages Posted: 6 Dec 2018

See all articles by Gavin Goy

Gavin Goy

University of Amsterdam - Faculty of Economics and Business (FEB)

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE); CeNDEF; Tinbergen Institute

Kostas Mavromatis

De Nederlandsche Bank

Date Written: December 4, 2018

Abstract

This paper studies the macroeconomic effects of central bank forward guidance when central bank credibility is endogenous. In particular, we take a stylized New Keynesian model with an occasionally binding zero lower bound constraint on nominal interest rates and heterogeneous and boundedly rational households. The central bank uses a bivariate VAR to forecast, not taking into account the time-variation in the distribution of aggregate expectations. In this framework, we extend the central bank's toolkit to allow for the publication of its own forecasts (Delphic guidance) and the commitment to a future path of the nominal interest rate (Odyssean guidance). We find that both Delphic and Odyssean forward guidance increase the likelihood of recovery from a liquidity trap. Even though Odyssean guidance alone appears more powerful, we find it to increase ex post macroeconomic volatility and thus reduce welfare.

Keywords: Forward Guidance, Heterogeneous Beliefs, Bounded Rationality, Central Bank Learning

JEL Classification: E03, E12, E58

Suggested Citation

Goy, Gavin and Hommes, Cars H. and Mavromatis, Kostas, Forward Guidance and the Role of Central Bank Credibility under Heterogeneous Beliefs (December 4, 2018). De Nederlandsche Bank Working Paper No. 614. Available at SSRN: https://ssrn.com/abstract=3296214 or http://dx.doi.org/10.2139/ssrn.3296214

Gavin Goy (Contact Author)

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Cars H. Hommes

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Center for Nonlinear Dynamics in Economics and Finance
1018 WB Amsterdam
Netherlands
+31 20 525 4246 (Phone)
+31 20 525 4349 (Fax)

CeNDEF ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://www1.fee.uva.nl/cendef/

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Kostas Mavromatis

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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