A Theory of The Procyclical Effectiveness of Forward Guidance

Paweł Kopiec ()

No 2022-081, KAE Working Papers from Warsaw School of Economics, Collegium of Economic Analysis

Abstract: I study the dependence of the forward guidance effectiveness on the level of economic slack. I use the model with price rigidities and uninsured unemployment risk and apply both analytical and numerical methods to study the forward guidance transmission in both''normal time'' and the crisis during which the unemployment rate rises by 150 percent. High unemployment accompanied by low job-finding rates raises the unemployment risk and increases precautionary motives. This, in turn, constrains the ability of the monetary authority to boost current demand by announcing cuts in future policy rates. The severity of that limitation increases with the time horizon of the announced change in interest rate. Quantitatively, the drop in the interest rate elasticity of aggregate consumption between the horizon of the interest rate cut equal to zero (i.e. the standard monetary policy shock) and the horizon equal to 15 quarters is 35.3% larger in the crisis than in ''normal time''. These more pronounced horizon effects imply that the forward guidance effectiveness is in general lower in the crisis than in''normal times''.

Keywords: forward guidance; monetary policy; heterogeneous agents; frictional narkets; unemployment (search for similar items in EconPapers)
JEL-codes: D30 D31 D52 E21 E24 E43 E52 E58 (search for similar items in EconPapers)
Pages: 68 pages
Date: 2022-12
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:sgh:kaewps:2022081

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