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Threshold-based forward guidance: hedging the zero bound

Lena Boneva (), Richard Harrison () and Matt Waldron ()
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Lena Boneva: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

Authors registered in the RePEc Author Service: Lena Mareen Koerber

No 561, Bank of England working papers from Bank of England

Abstract: Motivated by policies implemented by some central banks in response to the financial crisis, we use a simple New Keynesian model to study a particular form of forward guidance. We assume that the policy maker makes a state-contingent commitment to hold the policy rate at the zero lower bound (ZLB) in a way that ensures that specific macroeconomic variables (eg inflation) do not breach particular ‘thresholds’. In common with other similar policies, threshold-based forward guidance (TBFG) can be used to stimulate the economy at the ZLB via a commitment to hold the policy rate lower-for-longer than would otherwise have been the case. But TBFG also acts as a hedge against the asymmetric effects of shocks. That is because if further adverse shocks arise, prolonging the recession, exit would be expected to occur later and the policy would provide additional stimulus. In contrast, if positive shocks arrive, so that the economy recovers more quickly than originally expected, exit would be expected to occur sooner, thereby removing some of the policy stimulus. This hedging property of TBFG also means that there is a relatively low incentive for policy makers to renege on the policy, unlike lower-for-longer policies that depend purely on calendar time.

Keywords: New Keynesian model; monetary policy; zero lower bound; forward guidance; thresholds (search for similar items in EconPapers)
JEL-codes: E17 E31 E52 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2015-10-23
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Working Paper: Threshold-based forward guidance: hedging the zero bound (2017) Downloads
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