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Forward Guidance: Is It Useful After the Crisis?

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  • Maliar, Lilia
  • Taylor, John B.

Abstract

During recent economic crisis, when nominal interest rates were at their effective lower bounds, central banks used forward guidance -- announcements about future policy rates -- to conduct their monetary policy. Many policymakers believe that forward guidance will remain in use after the end of the crisis, however, there is uncertainty about its effectiveness. In this paper, we study the impact of forward guidance in a stylized new Keynesian economy away from the effective lower bound on nominal interest rates. Using closed-form solutions, we show that the impact of forward guidance on the economy depends critically on a specific monetary policy rule, ranging from non-existing to immediate and unrealistically large, the so-called forward guidance puzzle. We show that the puzzle occurs under very special -- empirically implausible and socially suboptimal -- monetary policy rules, whereas empirically relevant Taylor rules lead to sensible implications.

Suggested Citation

  • Maliar, Lilia & Taylor, John B., 2018. "Forward Guidance: Is It Useful After the Crisis?," CEPR Discussion Papers 13383, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13383
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    References listed on IDEAS

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    1. Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Forward Guidance And The State Of The Economy," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1593-1624, October.
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    3. John H. Cochrane, 2011. "Determinacy and Identification with Taylor Rules," Journal of Political Economy, University of Chicago Press, vol. 119(3), pages 565-615.
    4. Lilia Maliar & Serguei Maliar & John B. Taylor & Inna Tsener, 2020. "A tractable framework for analyzing a class of nonstationary Markov models," Quantitative Economics, Econometric Society, vol. 11(4), pages 1289-1323, November.
    5. Iván Werning, 2015. "Incomplete Markets and Aggregate Demand," NBER Working Papers 21448, National Bureau of Economic Research, Inc.
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    7. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828, Elsevier.
    8. Alisdair McKay & Emi Nakamura & Jón Steinsson, 2016. "The Power of Forward Guidance Revisited," American Economic Review, American Economic Association, vol. 106(10), pages 3133-3158, October.
    9. 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.
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    1. > Macroeconomics > Monetary Theory

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    Cited by:

    1. Christian Pfister & Jean-Guillaume Sahuc, 2020. "Unconventional monetary policies: A stock-taking exercise," Revue d'économie politique, Dalloz, vol. 130(2), pages 137-169.
    2. Maliar, Lilia, 2018. "Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap," CEPR Discussion Papers 13384, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    forward guidance; New Keynesian Model;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • 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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