Credible Forward Guidance

50 Pages Posted: 17 Jul 2019

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Takeki Sunakawa

Kobe University

Date Written: 2019-05-17

Abstract

We analyze credible forward guidance policies in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates by solving a series of optimal sustainable policy problems indexed by the duration of reputational loss. Lower-for-longer policies --- while effective in stimulating the economy at the ELB --- are potentially time-inconsistent, as the associated overheating of the economy in the aftermath of a crisis is undesirable ex post. However, if reneging on a lower-for-longer promise leads to a loss of reputation and prevents the central bank from effectively using lower-for-longer policies in future crises, these policies can be time-consistent. We find that, even without an explicit commitment technology, the central bank can still credibly keep the policy rate at the ELB for an extended period --- though not as extended under the optimal commitment policy --- and meaningfully mitigate the adverse effects of the ELB constraint on economy activit y.

Keywords: Credibility, Effective Lower Bound, Forward Guidance, Sustainable Plan, Time-Consistency

JEL Classification: E63, E52, E61, E62, E32

Suggested Citation

Nakata, Taisuke and Sunakawa, Takeki, Credible Forward Guidance (2019-05-17). FEDS Working Paper No. 2019-037. Available at SSRN: https://ssrn.com/abstract=3417740 or http://dx.doi.org/10.17016/FEDS.2019.037

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

Takeki Sunakawa

Kobe University ( email )

2-1, Rokkodai-cho, Nada-ku
Kobe, 657-8501, 657-8501
Japan

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