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The stimulative effect of forward guidance

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Author Info

  • Gavin, William T.

    ()
    (Federal Reserve Bank of St. Louis)

  • Keen, Benjamin D.

    ()
    (University of Oklahoma)

  • Richter, Alexander

    ()
    (Auburn University)

  • Throckmorton, Nathaniel

    ()
    (Indiana University)

Abstract

This article quantifies the stimulative effect of central bank forward guidance—the public announcement of the intended path for monetary policy in the future—when the nominal interest rate is stuck at its zero lower bound (ZLB). We use a global solution to a conventional nonlinear New Keynesian model to show how the forward guidance horizon impacts the stimulative effect. Forward guidance enters our model as news shocks to the monetary policy rule, which commits the central bank to a lower policy rate than its policy rule suggests. The success of forward guidance depends on whether households expect the economy to recover. When households expect a recovery, forward guidance about a future expansionary monetary policy shock lowers the expected nominal interest rate and increases current consumption. A longer forward guidance horizon strengthens this effect, but at a decreasing rate.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2013-38.

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Length: 20 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:fip:fedlwp:2013-038

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Related research

Keywords: Monetary Policy; Forward Guidance; Zero Lower Bound; Global Solution Method;

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  1. Susanto Basu & Brent Bundick, 2012. "Uncertainty shocks in a model of effective demand," Working Papers 12-15, Federal Reserve Bank of Boston.
  2. Gust, Christopher & López-Salido, J David & Smith, Matthew E, 2012. "The Empirical Implications of the Interest-Rate Lower Bound," CEPR Discussion Papers 9214, C.E.P.R. Discussion Papers.
  3. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June.
  4. S. Borağan Aruoba & Frank Schorfheide, 2013. "Macroeconomic Dynamics Near the ZLB: A Tale of Two Equilibria," NBER Working Papers 19248, National Bureau of Economic Research, Inc.
  5. Levin, Andrew & López-Salido, J David & Nelson, Edward & Yun, Tack, 2009. "Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound," CEPR Discussion Papers 7581, C.E.P.R. Discussion Papers.
  6. Wolman, Alexander L, 2005. "Real Implications of the Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 273-96, April.
  7. Nathaniel Throckmorton & Benjamin Keen & Alexander Richter & William Gavin, 2013. "Global Dynamics at the Zero Lower Bound," 2013 Meeting Papers 839, Society for Economic Dynamics.
  8. Wilbur John Coleman II, 1989. "Equilibrium in a production economy with an income tax," International Finance Discussion Papers 366, Board of Governors of the Federal Reserve System (U.S.).
  9. Refet Gürkaynak & Brian Sack, 2005. "Do Actions Speak Louder Than Words?The Response of Asset Prices to Monetary Policy Actions and Statements," Computing in Economics and Finance 2005 323, Society for Computational Economics.
  10. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  11. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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