A Theory of The Procyclical Effectiveness of Forward Guidance

Paweł Kopiec ()

No 2022-081, KAE Working Papers from Warsaw School of Economics, Collegium of Economic Analysis

Abstract: I study the dependence of the forward guidance effectiveness on the levelof economic slack. I use the model with price rigidities and uninsured unemploymentrisk and apply both analytical and numerical methods to studythe forward guidance transmission in both “normal times” and the crisis duringwhich the unemployment rate rises by 150 percent. High unemploymentaccompanied by low job-finding rates raises the unemployment risk and increasesprecautionary motives. This, in turn, constrains the ability of themonetary authority to boost current demand by announcing cuts in futurepolicy rates. The severity of that limitation increases with the time horizonof the announced change in interest rate. Quantitatively, the drop in theinterest rate elasticity of aggregate consumption between the horizon of theinterest rate cut equal to zero (i.e. the standard monetary policy shock) andthe horizon equal to 15 quarters is 35.3% larger in the crisis than in “normaltimes”. These more pronounced horizon effects imply that the forwardguidance effectiveness is in general lower in the crisis than in “normal times”.

Keywords: forward guidance; monetary policy; heterogeneous agents; frictional narkets; unemployment (search for similar items in EconPapers)
JEL-codes: D30 D31 D52 E21 E24 E43 E52 E58 (search for similar items in EconPapers)
Pages: 68 pages
Date: 2022-12
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:sgh:kaewps:2022081

DOI: 10.33119/kaewps2022081

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