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Risks to Price Stability, the Zero Lower Bound, and Forward Guidance: A Real-Time Assessment


  • Günter Coenen

    (European Central Bank)

  • Anders Warne

    (European Central Bank)


This paper employs stochastic simulations of the New Area- Wide Model—a microfounded open-economy model developed at the ECB—to investigate the consequences of the zero lower bound on nominal interest rates for the evolution of risks to price stability in the euro area during the recent financial crisis. Using a formal measure of the balance of risks, which is derived from policymakers’ preferences about inflation outcomes, we first show that downside risks to price stability were considerably greater than upside risks during the first half of 2009, followed by a gradual rebalancing of these risks until mid-2011 and a renewed deterioration thereafter. We find that the lower bound has induced a noticeable downward bias in the risk balance throughout our evaluation period because of the implied amplification of deflation risks. We then illustrate that, with nominal interest rates close to zero, forward guidance in the form of a time-based conditional commitment to keep interest rates low for longer can be successful in mitigating downside risks to price stability. However, we find that the provision of time-based forward guidance may give rise to upside risks over the medium term if extended too far into the future. By contrast, time-based forward guidance complemented with a threshold condition concerning tolerable future inflation can provide insurance against the materialization of such upside risks.

Suggested Citation

  • Günter Coenen & Anders Warne, 2014. "Risks to Price Stability, the Zero Lower Bound, and Forward Guidance: A Real-Time Assessment," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 7-54, June.
  • Handle: RePEc:ijc:ijcjou:y:2014:q:2:a:1

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    References listed on IDEAS

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    Cited by:

    1. Gavin, William T. & Keen, Benjamin D. & Richter, Alexander & Throckmorton, Nathaniel, 2013. "The stimulative effect of forward guidance," Working Papers 2013-38, Federal Reserve Bank of St. Louis, revised 30 Apr 2014.
    2. Chris McDonald & Craig Thamotheram & Shaun P. Vahey & Elizabeth C. Wakerly, 2016. "Assessing the economic value of probabilistic forecasts in the presence of an inflation target," Reserve Bank of New Zealand Discussion Paper Series DP2016/10, Reserve Bank of New Zealand.
    3. Boneva, Lena & Harrison, Richard & Waldron, Matt, 2015. "Threshold-based forward guidance: hedging the zero bound," Bank of England working papers 561, Bank of England.
    4. Alex Haberis & Richard Harrison & Matt Waldron, 2014. "Transitory interest-rate pegs under imperfect credibility," Discussion Papers 1422, Centre for Macroeconomics (CFM).
    5. repec:bla:jecsur:v:31:y:2017:i:3:p:678-711 is not listed on IDEAS
    6. Harrison, Richard, 2015. "Estimating the effects of forward guidance in rational expectations models," European Economic Review, Elsevier, vol. 79(C), pages 196-213.
    7. Smets, Frank & Warne, Anders & Wouters, Rafael, 2014. "Professional forecasters and real-time forecasting with a DSGE model," International Journal of Forecasting, Elsevier, vol. 30(4), pages 981-995.
    8. Haberis, Alex & Harrison, Richard & Waldron, Matthew, 2017. "Uncertain forward guidance," Bank of England working papers 654, Bank of England.
    9. Haberis, Alex & Masolo, Riccardo & Reinold, Kate, 2016. "Deflation probability and the scope for monetary loosening in the United Kingdom," Bank of England working papers 627, Bank of England.
    10. Riyad Abubaker, 2016. "Consumption and Money Uncertainty at the Zero Lower Bound," Economics Bulletin, AccessEcon, vol. 36(1), pages 449-463.
    11. Andrew Binning & Junior Maih, 2017. "Modelling Occasionally Binding Constraints Using Regime-Switching," Working Paper 2017/23, Norges Bank.
    12. repec:kuk:journl:v:50:y:2017:i:4:p:455-488 is not listed on IDEAS
    13. Richhild Moessner & David-Jan Jansen & Jakob de Haan, 2017. "Communication About Future Policy Rates In Theory And Practice: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 31(3), pages 678-711, July.
    14. Coenen, Günter & Ehrmann, Michael & Gaballo, Gaetano & Hoffmann, Peter & Nakov, Anton & Nardelli, Stefano & Persson, Eric & Strasser, Georg, 2017. "Communication of monetary policy in unconventional times," Working Paper Series 2080, European Central Bank.
    15. Andrew Binning & Junior Maih, 2016. "Forecast uncertainty in the neighborhood of the effective lower bound: How much asymmetry should we expect?," Working Paper 2016/13, Norges Bank.
    16. Colavecchio, Roberta & Amisano, Gianni & Fagan, Gabriel, 2014. "A money-based indicator for deflation risk," Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100595, Verein für Socialpolitik / German Economic Association.
    17. Schmidt, Sebastian & Nakata, Taisuke, 2016. "The risk-adjusted monetary policy rule," Working Paper Series 1985, European Central Bank.
    18. Smets, Frank & Warne, Anders & Wouters, Raf, 2013. "Professional forecasters and the real-time forecasting performance of an estimated new keynesian model for the euro area," Working Paper Series 1571, European Central Bank.
    19. McDonald, Christopher & Thamotheram, Craig & Vahey, Shaun P. & Wakerly, Elizabeth C., 2015. "Assessing the Economic Value of Probabilistic Forecasts in the Presence of an Inflation Target," EMF Research Papers 09, Economic Modelling and Forecasting Group.
    20. repec:bla:ecinqu:v:55:y:2017:i:4:p:1593-1624 is not listed on IDEAS
    21. repec:prg:jnlpep:v:2017:y:2017:i:5:id:631:p:523-541 is not listed on IDEAS
    22. Kenny, Geoff & Dovern, Jonas, 2017. "The long-term distribution of expected inflation in the euro area: what has changed since the great recession?," Working Paper Series 1999, European Central Bank.
    23. van Holle, Frederiek, 2017. "Essays in empirical finance and monetary policy," Other publications TiSEM 30d11a4b-7bc9-4c81-ad24-5, Tilburg University, School of Economics and Management.
    24. Ciccarelli, Matteo & Osbat, Chiara, 2017. "Low inflation in the euro area: Causes and consequences," Occasional Paper Series 181, European Central Bank.
    25. Michal Franta & Tomas Holub & Petr Kral & Ivana Kubicova & Katerina Smidkova & Borek Vasicek, 2014. "The Exchange Rate as an Instrument at Zero Interest Rates: The Case of the Czech Republic," Research and Policy Notes 2014/03, Czech National Bank, Research Department.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies


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