Transitory interest-rate pegs under imperfect credibility
In this paper we show that the macroeconomic effects of a transient interestrate peg can be significantly dampened when the peg is perceived to be imperfectly credible by the private sector. By doing so, we provide a solution to what has become known as the "forward guidance puzzle". This is the finding that pegging nominal interest rates to a specific value or path for an extended, yet finite, period of time in New Keynesian models generates macroeconomic responses that are implausibly large. This puzzle has been of interest because several central banks have implemented "forward guidance" which has been interpreted by some as a promise to hold the policy rate lower than had been previously expected: a so-called lower-for-longer (LFL) policy. The New Keynesian models that these central banks routinely use for policy analysis would predict that LFL policies generate very large effects. The possibility that LFL policies might be imperfectly credible arises from their potential to be time inconsistent . Indeed, using an ad-hoc loss function for the central bank we show that it may have an incentive to renounce the LFL policy along the full commitment path. We examine cases in which the degree of imperfect credibility is exogenous and in which it is endogenously related to the state of the economy via the policymaker's incentive to renounce. Allowing for endogenous imperfect credibility tends to dampen the response of macroeconomic variables to an LFL policy announcement by more than under exogenous imperfect credibility.
|Date of creation:||Jul 2014|
|Date of revision:|
|Contact details of provider:|| Web page: http://www.centreformacroeconomics.ac.uk/|
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-35, October.
- Roberds, William, 1987.
"Models of Policy under Stochastic Replanning,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 731-55, October.
- Coenen, Günter & Warne, Anders, 2013.
"Risks to price stability, the zero lower bound and forward guidance: a real-time assessment,"
Working Paper Series
1582, European Central Bank.
- 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.
- Coenen, Günter & Warne, Anders, 2013. "Risks to price stability, the zero lower bound and forward guidance: A real-time assessment," CFS Working Paper Series 2013/06, Center for Financial Studies (CFS).
- Ernst Schaumburg & Andrea Tambalotti, 2003.
"An Investigation of the Gains from Commitment in Monetary Policy,"
- Schaumburg, Ernst & Tambalotti, Andrea, 2007. "An investigation of the gains from commitment in monetary policy," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 302-324, March.
- Ernst Schaumburg & Andrea Tambalotti, 2003. "An investigation of the gains from commitment in monetary policy," Staff Reports 171, Federal Reserve Bank of New York.
- Andrea Tambalotti & Ernst Schaumburg, 2004. "An Investigation of the Gains from Commitment in Monetary Policy," Econometric Society 2004 North American Summer Meetings 282, Econometric Society.
- Christoffel, Kai & Coenen, Günter & Warne, Anders, 2008. "The New Area-Wide Model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series 0944, European Central Bank.
- Burgess, Stephen & Fernandez-Corugedo, Emilio & Groth, Charlotta & Harrison, Richard & Monti, Francesca & Theodoridis, Konstantinos & Waldron, Matt, 2013. "The Bank of England's forecasting platform: COMPASS, MAPS, EASE and the suite of models," Bank of England working papers 471, Bank of England.
- Tom Holden & Michael Paetz, 2012.
"Efficient simulation of DSGE models with inequality constraints,"
School of Economics Discussion Papers
1612, School of Economics, University of Surrey.
- Tom Holden & Michael Paetz, 2012. "Efficient Simulation of DSGE Models with Inequality Constraints," Quantitative Macroeconomics Working Papers 21207b, Hamburg University, Department of Economics.
- Davide Debortoli & Ricardo Nunes, 2007. "Loose commitment," International Finance Discussion Papers 916, Board of Governors of the Federal Reserve System (U.S.).
- Hughes, Abigail & Saleheen, Jumana, 2012. "UK labour productivity since the onset of the crisis — an international and historical perspective," Bank of England Quarterly Bulletin, Bank of England, vol. 52(2), pages 138-146.
When requesting a correction, please mention this item's handle: RePEc:cfm:wpaper:1422. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Martin Hannon)
If references are entirely missing, you can add them using this form.