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The Power of Forward Guidance Revisited

Listed author(s):
  • Alisdair McKay
  • Emi Nakamura
  • Jón Steinsson

In recent years, central banks have increasingly turned to forward guidance as a central tool of monetary policy. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and these effects grow with the horizon of the forward guidance. We present a model in which the power of forward guidance is highly sensitive to the assumption of complete markets. When agents face uninsurable income risk and borrowing constraints, a precautionary savings effect tempers their responses to changes in future interest rates. As a consequence, forward guidance has substantially less power to stimulate the economy.

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 106 (2016)
Issue (Month): 10 (October)
Pages: 3133-3158

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Handle: RePEc:aea:aecrev:v:106:y:2016:i:10:p:3133-58
Note: DOI: 10.1257/aer.20150063
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  6. Oh, Hyunseung & Reis, Ricardo, 2012. "Targeted transfers and the fiscal response to the great recession," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 50-64.
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