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Optimal Forward Guidance

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  • Bilbiie, Florin

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.

Suggested Citation

  • Bilbiie, Florin, 2016. "Optimal Forward Guidance," CEPR Discussion Papers 11251, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11251
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    More about this item

    Keywords

    Forward guidance; Liquidity trap; Zero lower bound; Optimal monetary policy; Heterogenous agents; Heterogenous beliefs; Incomplete markets; Unemployment risk; Hand-to-mouth;
    All these keywords.

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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