Credible Forward Guidance
50 Pages Posted: 17 Jul 2019
Date Written: 2019-05-17
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: Suggested Citation