State‐Dependent Forward Guidance and the Problem of Inconsistent Announcements

Julian A. Parra‐Polania
Authors registered in the RePEc Author Service: Julián Andrés Parra-Polanía

German Economic Review, 2019, vol. 20, issue 4, e1019-e1027

Abstract: Forward guidance can be provided as an unconditional promise, i.e. commitment to a specific low policy rate. Alternatively, the promise may include an escape clause, i.e. a condition defining the state of the economy under which the central bank would not keep such a low rate and, instead, it would revert to setting policy under discretion. The escape clause can be expressed as a threshold in terms of a specific variable. The present paper shows that, when such a threshold is expressed in terms of an endogenous variable (e.g. output, inflation), there are cases where it becomes impossible for the central bank to act in a way that is consistent with its promise. Consistency imposes limits on the policy rate that can be set since reverting immediately to the optimal discretionary rate can be incompatible with exceeding the threshold.

Date: 2019
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https://doi.org/10.1111/geer.12201

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Journal Article: State-Dependent Forward Guidance and the Problem of Inconsistent Announcements (2019)
Working Paper: State-dependent Forward Guidance and the Problem of Inconsistent Announcements (2018)
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