Effects of State-Dependent Forward Guidance, Large-Scale Asset Purchases and Fiscal Stimulus in a Low-Interest-Rate Environment

52 Pages Posted: 8 Feb 2020

See all articles by Günter Coenen

Günter Coenen

European Central Bank (ECB)

Carlos Montes-Galdon

European Central Bank

Frank Smets

European Central Bank (ECB); KU Leuven - Center for Economic Studies

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Date Written: January 03, 2020

Abstract

We study the incidence and severity of lower-bound episodes and the efficacy of three types of state-dependent policies — forward guidance about the future path of interest rates, large-scale asset purchases and spending-based fiscal stimulus — in ameliorating the adverse consequences stemming from the effective lower bound on nominal interest rates. In particular, we focus on the euro area economy and examine, using the ECB’s New Area- Wide Model, the consequences of the lower bound both for the near-term economic outlook, characterised by persistently low nominal interest rates and inflation, and in a lasting low-real-interest-rate world. Our findings suggest that, if unaddressed, the lower bound can have very substantial costs in terms of worsened macroeconomic performance. Forward guidance, if fully credible, is most powerful and can largely undo the distortionary effects due to the lower bound. A combination of imperfectly credible forward guidance, asset purchases and fiscal stimulus is almost equally effective, in particular when asset purchases enhance the credibility of the forward guidance policy via a signalling effect.

Keywords: Effective lower bound, monetary policy, forward guidance, asset purchases, fiscal policy, euro area

JEL Classification: E31, E32, E37, E52, E62

Suggested Citation

Coenen, Günter and Montes-Galdon, Carlos and Smets, Frank, Effects of State-Dependent Forward Guidance, Large-Scale Asset Purchases and Fiscal Stimulus in a Low-Interest-Rate Environment (January 03, 2020). CFS Working Paper, No. 639, 2020. Available at SSRN: https://ssrn.com/abstract=3522191 or http://dx.doi.org/10.2139/ssrn.3522191

Günter Coenen (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7887 (Phone)
+49 69 1344 6575 (Fax)

Carlos Montes-Galdon

European Central Bank ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Frank Smets

European Central Bank (ECB) ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany
+49 69 1344 6550 (Phone)
+49 69 1344 6575 (Fax)

KU Leuven - Center for Economic Studies ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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