Nominal Debt and the Heterogeneous Effects of Forward Guidance

Francesco Ferrante and Matthias Paustian
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Matthias Paustian: Federal Reserve Board

No 1256, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We develop an incomplete-markets heterogeneous agent New-Keynesian (HANK) model in which households are allowed to borrow using nominal debt. We show that, in this framework, forward guidance, that is the promise by the central bank to lower future interest rates, can be a powerful policy tool, especially when the economy is in a liquidity trap. In our model, expected lower rates imply a future transfer of wealth from savers to borrowers, reducing precautionary motives and stimulating current demand and inflation. In addition, at the time of the policy announcement, debt deflation generates also a wealth transfer towards constrained agents, who have high marginal propensity to consume, further increasing aggregate consumption and inflation, and igniting a positive feedback loop. These results contrast with previous research on HANK models, which focused on frameworks where agents were not allowed to borrow, and which found negligible effects of forward guidance.

Date: 2019
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:1256

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