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Effects of state-dependent forward guidance, large-scale asset purchases and fiscal stimulus in a low-interest-rate environment

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  • Coenen, Günter
  • Montes-Galdón, Carlos
  • Smets, Frank

Abstract

We study the incidence and severity of periods with a binding effective lower bound on nominal interest rates and the efficacy of three types of state-dependent policies—forward guidance about the path of future interest rates, large-scale asset purchases and spending-based fiscal stimulus—in mitigating the detrimental consequences of the lower bound for macroeconomic stability. Based on the ECB’s New Area-Wide Model of the euro area, our findings suggest that, if left unaddressed, the lower bound can cause substantial macroeconomic distortions. In the near term, forward guidance, if fully credible, is most powerful and can largely undo these distortions. A combination of imperfectly credible forward guidance, asset purchases and fiscal stimulus is almost equally effective, especially when asset purchases enhance the credibility of the forward-guidance policy via a signalling effect. In the long run, with an equilibrium real rate as low as zero, a combination of all three policies is needed to materially reduce the distortions. JEL Classification: E31, E32, E37, E52, E62

Suggested Citation

  • Coenen, Günter & Montes-Galdón, Carlos & Smets, Frank, 2020. "Effects of state-dependent forward guidance, large-scale asset purchases and fiscal stimulus in a low-interest-rate environment," Working Paper Series 2352, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20202352
    Note: 241047
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    More about this item

    Keywords

    asset purchases; effective lower bound; euro area; fiscal policy; forward guidance; monetary policy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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