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Credible Forward Guidance

Taisuke Nakata and Takeki Sunakawa ()

No 2019-037, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: 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 find 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 economy activit y.

Keywords: Time-Consistency; Sustainable Plan; Forward Guidance; Effective Lower Bound; Credibility (search for similar items in EconPapers)
JEL-codes: E63 E32 E62 E52 E61 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2019-05-17, Revised 2019-05-17
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2019-37

DOI: 10.17016/FEDS.2019.037

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