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Credible Forward Guidance

Taisuke Nakata and Takeki Sunakawa ()
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Taisuke Nakata: University of Tokyo

No CARF-F-484, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: How can the central bank credibly implement a "lower-for-longer" strategy? To answer this question, we analyze credible forward guidance policies in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates by solving a series of optimal sustainable policy problems indexed by the duration of reputational loss. Lower-for-longer policies - while effective in stimulating the economy at the ELB - are potentially time-inconsistent, as the associated overheating of the economy in the aftermath of a crisis is undesirable ex post. However, if reneging on a lower-for-longer promise leads to a loss of reputation and prevents the central bank from effectively using lower-for-longer policies in future crises, these policies can be time-consistent. We fi nd that, even without an explicit commitment technology, the central bank can still credibly keep the policy rate at the ELB for an extended period - though not as extended under the optimal commitment policy - and meaningfully mitigate the adverse effects of the ELB constraint on economic activity.

Pages: 50
Date: 2020-05
New Economics Papers: this item is included in nep-mac and nep-mon
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Working Paper: Credible Forward Guidance (2019) Downloads
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