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Threshold-based forward guidance: hedging the zero bound

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  • Boneva, Lena
  • Harrison, Richard
  • Waldron, Matt

Abstract

"Threshold-based forward guidance" (TBFG) is a state-contingent commitment to hold the policy rate at the zero lower bound until macroeconomic variables breach particular "thresholds". Though such guidance has been implemented in practice, little is known about how this policy works in theory. This paper fills that gap by studying threshold-based guidance as a tool to improve outcomes at the zero bound within a general equilibrium framework. Policymakers have rarely advocated using TBFG to provide stimulus, in part reflecting skepticism about their ability to commit credibly to time inconsistent behavior. We show that TBFG can be used to provide temporary stimulus, while also limiting the time inconsistency of policy promises. We also show that existence of a unique equilibrium requires the policymaker to specify how the thresholds should be interpreted, as well as their values. The optimal design of the threshold conditions depends on the relative importance of those shocks that induce a trade-off between stabilizing output and inflation and those that do not. With an appropriate choice of thresholds, TBFG outperforms forward guidance based purely on calendar time and comes close to mimicking outcomes under optimal commitment policy.

Suggested Citation

  • Boneva, Lena & Harrison, Richard & Waldron, Matt, 2017. "Threshold-based forward guidance: hedging the zero bound," CEPR Discussion Papers 11749, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11749
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    Citations

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    Cited by:

    1. Adrian, Tobias & de Fontnouvelle, Patrick & Yang, Emily & Zlate, Andrei, 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.
    2. repec:bla:jecsur:v:31:y:2017:i:3:p:678-711 is not listed on IDEAS
    3. Haberis, Alex & Harrison, Richard & Waldron, Matthew, 2017. "Uncertain forward guidance," Bank of England working papers 654, Bank of England.
    4. Mitsuru Katagiri, 2016. "Forward Guidance as a Monetary Policy Rule," Bank of Japan Working Paper Series 16-E-6, Bank of Japan.
    5. 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.
    6. Paul Hubert & Fabien Labondance, 2016. "The Effect of ECB Forward Guidance on Policy Expectations," Working Papers hal-01394821, HAL.

    More about this item

    Keywords

    forward guidance; monetary policy; thresholds; zero lower bound;

    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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