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Forward guidance reassessed: Stabilizability under endogenous policy rules

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  • Hallett, Andrew Hughes
  • Acocella, Nicola

Abstract

It is well known that, in a world of rational expectations, time inconsistency is at the heart of policy failures. Strategic policy announcements in the form of forward guidance have assumed a more important role particularly when expansionary monetary policy is blocked by the zero lower bound (ZLB). This paper deals with the possibility that policy announcements avoid time inconsistency. This makes monetary policy more credible. Nevertheless, the non-credibility of an announcement of future policy can derive from a number of obstacles, including the possibility that the economy is hit by some kinds of shocks, particularly large-sized shocks. We show that shocks of any size can always be controlled by suitable policy rules if their design includes forward guidance and state contingent policy rules, as well as an appropriate but not restrictive choice of the policy parameters. This provides enhanced controllability and stabilize-ability – in particular in those cases where those properties had not been available before. To illustrate, we provide examples based on a dynamic representation of a reduced form DSGE model derived from the New Keynesian (NK) approach to modeling the economy. It turns out that there are some differences between the bounds on the permitted policy parameters which depend on whether we are tied to the ZLB or not. But stabilizing policy rules under forward guidance are always feasible and always available.

Suggested Citation

  • Hallett, Andrew Hughes & Acocella, Nicola, 2019. "Forward guidance reassessed: Stabilizability under endogenous policy rules," Journal of Macroeconomics, Elsevier, vol. 59(C), pages 325-335.
  • Handle: RePEc:eee:jmacro:v:59:y:2019:i:c:p:325-335
    DOI: 10.1016/j.jmacro.2018.12.006
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    References listed on IDEAS

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    More about this item

    Keywords

    Stabilizability; Dynamic controllability; Rational expectations; Zero Lower Bound; Forward Guidance;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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