Forward guidance with an escape clause: When half a promise is better than a full one

Maria Lucia Florez-Jimenez () and Julián Parra-Polanía

No 11143, Borradores de Economia from Banco de la Republica

Abstract: Using a three-equation New Keynesian model we find that incorporating an escape clause (EC) into Forward Guidance (FG) is welfare improving as it allows the monetary authority to avoid cases in which the cost of reduced flexibility is too high. The EC provides the central bank with another instrument (additional to the promised policy rate), the announced threshold. The greater the size of the recessionary shock the lower the optimal promised rate and the higher the optimal threshold (i.e. the higher the probability of delivering the promised rate). While FG with an EC is better than discretion for facing any zero-lower bound (ZLB) situation, unconditional FG performs better than discretion only in the most extreme 16% of ZLB events. Furthermore, even for very large recessionary shocks it is not optimal to make unconditional promises.

Keywords: Forward guidance; escape clause; zero lower bound; central bank communication (search for similar items in EconPapers)
JEL-codes: E47 E52 E58 (search for similar items in EconPapers)
Pages: 15
Date: 2014-03-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Forward guidance with an escape clause: when half a promise is better than a full one (2016)
Working Paper: Forward guidance with an escape clause: When half a promise is better than a full one (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:011143

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