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Forward Guidance at the Zero Lower Bound in a Model of Price-Level Targeting

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  • Gerhard Illing
  • Thomas Siemsen

Abstract

We study monetary policy at the zero lower bound in a traceable three-period model, in which price-level targeting emerges endogenously in the welfare function. We characterize optimal price-level forward guidance under discretion and commitment. Potentially non-monotonic discretionary welfare losses are lowest with perfectly flexible prices. Price-level targeting introduces a new constraint on optimal forward guidance that restricts the credible amount of overshooting. With this constraint, the zero lower bound may be binding even after the shock has abated. We characterize conditions when the commitment to hold nominal rates at zero for an extended period is optimal. Finally, we introduce government spending and show that under persistently low policy rates optimal government spending becomes more front-loaded, while procyclical austerity fares worse than discretionary government spending.

Suggested Citation

  • Gerhard Illing & Thomas Siemsen, 2016. "Forward Guidance at the Zero Lower Bound in a Model of Price-Level Targeting," CESifo Economic Studies, CESifo, vol. 62(1), pages 47-67.
  • Handle: RePEc:oup:cesifo:v:62:y:2016:i:1:p:47-67.
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    File URL: http://hdl.handle.net/10.1093/cesifo/ifv011
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    References listed on IDEAS

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    1. Jing Cynthia Wu & Fan Dora Xia, 2016. "Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(2-3), pages 253-291, March.
    2. John H. Cochrane, 2013. "The New-Keynesian Liquidity Trap," NBER Working Papers 19476, National Bureau of Economic Research, Inc.
    3. Michael Woodford, 2004. "Inflation targeting and optimal monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 86(Jul), pages 15-42.
    4. Benigno, Pierpaolo, 2015. "New-Keynesian economics: An AS–AD view," Research in Economics, Elsevier, vol. 69(4), pages 503-524.
    5. Michael Woodford, 2011. "Simple Analytics of the Government Expenditure Multiplier," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(1), pages 1-35, January.
    6. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    7. Hatcher, Michael & Minford, Patrick, 2014. "Stabilization policy, rational expectations and price-level versus infl‡ation targeting: a survey," CEPR Discussion Papers 9820, C.E.P.R. Discussion Papers.
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    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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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