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Forward Guidance and the State of the Economy

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  • Benjamin D. Keen
  • Alexander W. Richter
  • Nathaniel A. Throckmorton

Abstract

This paper examines the economic effects of forward guidance using a New Keynesian model with a zero lower bound (ZLB) constraint on the short-term nominal interest rate. Forward guidance is modeled with anticipated news shocks to the monetary policy rule. There are five key findings: (1) the stimulative effect of forward guidance falls as the economy deteriorates or as households expect a slower recovery because there is a smaller margin to lower expected policy rates; (2) longer forward guidance horizons do not generate increasingly larger impact effects on output when the total amount of news is fixed, unlike with an exogenous interest rate peg; (3) in steady state, an unanticipated shock has a larger impact effect on output than a news shock, but a news shock has a larger cumulative effect in every state of the economy; (4) at the ZLB, the cumulative effect on output from lengthening the forward guidance horizon increases over short horizons but decreases thereafter, which indicates the central bank faces limits on how far forward guidance can extend into the future and continue to add stimulus; and (5) forward guidance is stimulative in the absence of other shocks, but the observed effect on output is smaller or even negative if another shock simultaneously reduces demand.

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  • Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2015. "Forward Guidance and the State of the Economy," Auburn Economics Working Paper Series auwp2015-10, Department of Economics, Auburn University.
  • Handle: RePEc:abn:wpaper:auwp2015-10
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    Cited by:

    1. Bennani, Hamza, 2014. "The art of central banks' forward guidance at the zero lower bound," MPRA Paper 57043, University Library of Munich, Germany.
    2. Mitsuru Katagiri, 2016. "Forward Guidance as a Monetary Policy Rule," Bank of Japan Working Paper Series 16-E-6, Bank of Japan.
    3. Schmidt, Sebastian & Nakata, Taisuke & Hills, Timothy, 2016. "The risky steady state and the interest rate lower bound," Working Paper Series 1913, European Central Bank.
    4. Hughes Hallett Andrew & Nicola Acocella, "undated". "Stabilization and expanded commitment: a theory of forward guidance for economies with rational expectations," Working Papers 132/14, Sapienza University of Rome, Metodi e modelli per l'economia, il territorio e la finanza MEMOTEF.

    More about this item

    Keywords

    Monetary Policy; Forward Guidance; Zero Lower Bound; News Shocks;

    JEL classification:

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

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