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Threshold-based forward guidance: hedging the zero bound

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  • Boneva, Lena

    (Bank of England)

  • Harrison, Richard

    (Bank of England)

  • Waldron, Matt

    (Bank of England)

Abstract

Motivated by policies implemented by some central banks in response to the financial crisis, we use a simple New Keynesian model to study a particular form of forward guidance. We assume that the policy maker makes a state-contingent commitment to hold the policy rate at the zero lower bound (ZLB) in a way that ensures that specific macroeconomic variables (eg inflation) do not breach particular ‘thresholds’. In common with other similar policies, threshold-based forward guidance (TBFG) can be used to stimulate the economy at the ZLB via a commitment to hold the policy rate lower-for-longer than would otherwise have been the case. But TBFG also acts as a hedge against the asymmetric effects of shocks. That is because if further adverse shocks arise, prolonging the recession, exit would be expected to occur later and the policy would provide additional stimulus. In contrast, if positive shocks arrive, so that the economy recovers more quickly than originally expected, exit would be expected to occur sooner, thereby removing some of the policy stimulus. This hedging property of TBFG also means that there is a relatively low incentive for policy makers to renege on the policy, unlike lower-for-longer policies that depend purely on calendar time.

Suggested Citation

  • Boneva, Lena & Harrison, Richard & Waldron, Matt, 2015. "Threshold-based forward guidance: hedging the zero bound," Bank of England working papers 561, Bank of England.
  • Handle: RePEc:boe:boeewp:0561
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    Cited by:

    1. Paul Hubert & Fabien Labondance, 2016. "The Effect of ECB Forward Guidance on Policy Expectations," Working Papers hal-01394821, HAL.
    2. Gersbach, Hans & Liu, Yulin & Tischhauser, Martin, 2021. "Versatile forward guidance: escaping or switching?," Journal of Economic Dynamics and Control, Elsevier, vol. 127(C).
    3. Tobias Adrian & Patrick de Fontnouvelle & Emily Yang & Andrei Zlate, 2017. "Macroprudential policy: a case study from a tabletop exercise," Economic Policy Review, Federal Reserve Bank of New York, issue 23-1, pages 1-30.
    4. Haberis, Alex & Harrison, Richard & Waldron, Matthew, 2017. "Uncertain forward guidance," Bank of England working papers 654, Bank of England.
    5. Mitsuru Katagiri, 2016. "Forward Guidance as a Monetary Policy Rule," Bank of Japan Working Paper Series 16-E-6, Bank of Japan.
    6. 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.

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    More about this item

    Keywords

    New Keynesian model; 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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