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Threshold-based forward guidance

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  • Boneva, Lena
  • Harrison, Richard
  • Waldron, Matt

Abstract

When the monetary policy rate is at the zero bound, “threshold-based forward guidance” (TBFG) is a state-contingent promise to delay liftoff from the zero bound until macroeconomic variables breach particular “thresholds”. We study TBFG within a stochastic version of the workhorse New Keynesian model. We show that TBFG can be used to provide temporary stimulus, while also limiting the time inconsistency of policy promises. Existence of a unique equilibrium requires the policymaker to specify how the thresholds should be interpreted, as well as their values. With an appropriate choice of thresholds, TBFG outperforms forward guidance based purely on calendar time and substantially reduces welfare losses compared to the optimal time-consistent policy.

Suggested Citation

  • Boneva, Lena & Harrison, Richard & Waldron, Matt, 2018. "Threshold-based forward guidance," Journal of Economic Dynamics and Control, Elsevier, vol. 90(C), pages 138-155.
    • Handle: RePEc:eee:dyncon:v:90:y:2018:i:c:p:138-155
    DOI: 10.1016/j.jedc.2018.02.003
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    Cited by:

    1. Günter Coenen & Carlos Montes‐Galdón & Frank Smets, 2023. "Effects of State‐Dependent Forward Guidance, Large‐Scale Asset Purchases, and Fiscal Stimulus in a Low‐Interest‐Rate Environment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(4), pages 825-858, June.
    2. Julien Albertini & Valentin Jouvanceau & Stéphane Moyen, 2022. "State-Contingent Forward Guidance," Working Papers 2205, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    3. Coenen, Günter & Montes-Galdón, Carlos & Schmidt, Sebastian, 2021. "Macroeconomic stabilisation and monetary policy effectiveness in a low-interest-rate environment," Journal of Economic Dynamics and Control, Elsevier, vol. 132(C).
    4. Kohei Hasui & Teruyoshi Kobayashi & Tomohiro Sugo, 2019. "Irreversible monetary policy at the zero lower bound," Discussion Papers 1906, Graduate School of Economics, Kobe University.
    5. Edward Nelson, 2021. "The Emergence of Forward Guidance As a Monetary Policy Tool," Finance and Economics Discussion Series 2021-033, Board of Governors of the Federal Reserve System (U.S.).
    6. Hirokuni Iiboshi & Mototsugu Shintani & Kozo Ueda, 2022. "Estimating a Nonlinear New Keynesian Model with the Zero Lower Bound for Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 54(6), pages 1637-1671, September.
    7. Carola Conces Binder, 2021. "Central Bank Communication and Disagreement about the Natural Rate Hypothesis," International Journal of Central Banking, International Journal of Central Banking, vol. 17(2), pages 81-123, June.
    8. Hasui, Kohei & Kobayashi, Teruyoshi & Sugo, Tomohiro, 2021. "Optimal irreversible monetary policy," European Economic Review, Elsevier, vol. 134(C).
    9. Julien Albertini & Stéphane Moyen, 2020. "A General and Efficient Method for Solving Regime-Switching DSGE Models," Working Papers 2035, Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon.
    10. Fernando M. Duarte, 2016. "How to escape a liquidity trap with interest rate rules," Staff Reports 776, Federal Reserve Bank of New York.
    11. Haberis, Alex & Harrison, Richard & Waldron, Matt, 2019. "Uncertain policy promises," European Economic Review, Elsevier, vol. 111(C), pages 459-474.
    12. Liu, Shih-fu & Huang, Wei-chi & Lai, Ching-chong, 2020. "Could Fiscal Policies Overcome a Deep Recession at the Zero Lower Bound?," MPRA Paper 101282, University Library of Munich, Germany.
    13. Hess T. Chung & Etienne Gagnon & Taisuke Nakata & Matthias Paustian & Bernd Schlusche & James Trevino & Diego Vilán & Wei Zheng, 2019. "Monetary Policy Options at the Effective Lower Bound : Assessing the Federal Reserve's Current Policy Toolkit," Finance and Economics Discussion Series 2019-003, Board of Governors of the Federal Reserve System (U.S.).
    14. Parra-Polania Julian A., 2019. "State-Dependent Forward Guidance and the Problem of Inconsistent Announcements," German Economic Review, De Gruyter, vol. 20(4), pages 1019-1027, December.
    15. Daisuke Ida & Hirokuni Iiboshi, 2021. "The interaction of forward guidance in a two-country new Keynesian model," Papers 2103.12503, arXiv.org, revised Apr 2021.
    16. Harrison, Richard & Waldron, Matt, 2021. "Optimal policy with occasionally binding constraints: piecewise linear solution methods," Bank of England working papers 911, Bank of England.
    17. Hess Chung & Etienne Gagnon & Taisuke Nakata & Matthias Paustian & Bernd Schlusche & James Trevino & Diego Vilán & Wei Zheng, 2020. "Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit," CARF F-Series CARF-F-483, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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    More about this item

    Keywords

    Monetary policy; Zero lower bound; Forward guidance; Thresholds;
    All these keywords.

    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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