Optimal Forward Guidance

Florin Bilbiie

No 11251, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Optimal forward guidance (OFG) is the simple policy of keeping interest rates low for some time after the liquidity trap, moving straight to normal-times optimal policy thereafter, and determining the extra accommodation duration optimally. I solve for the optimal duration in closed form in a new-Keynesian model, where OFG is close to fully-optimal Ramsey. The simple rule "announce a duration of half of the trap’s duration times the disruption" is a good approximation and alleviates credibility problems. Because it anchors expectations of (delphic) agents who otherwise mistake commitment for bad news, the simple rule is often welfare-preferable to odyssean commitment.

Keywords: Forward guidance; Liquidity trap; Zero lower bound; Optimal monetary policy; Heterogenous agents; Heterogenous beliefs; Incomplete markets; Unemployment risk; Hand-to-mouth (search for similar items in EconPapers)
JEL-codes: E21 E31 E40 E50 (search for similar items in EconPapers)
Date: 2016-04
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (14)

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Journal Article: Optimal Forward Guidance (2019)
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