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Nominal Debt and the Heterogeneous Effects of Forward Guidance

Author

Listed:
  • Francesco Ferrante

    (Federal Reserve Board)

  • Matthias Paustian

    (Federal Reserve Board)

Abstract

We develop an incomplete-markets heterogeneous agent New-Keynesian (HANK) model in which households are allowed to borrow using nominal debt. We show that, in this framework, forward guidance, that is the promise by the central bank to lower future interest rates, can be a powerful policy tool, especially when the economy is in a liquidity trap. In our model, expected lower rates imply a future transfer of wealth from savers to borrowers, reducing precautionary motives and stimulating current demand and inflation. In addition, at the time of the policy announcement, debt deflation generates also a wealth transfer towards constrained agents, who have high marginal propensity to consume, further increasing aggregate consumption and inflation, and igniting a positive feedback loop. These results contrast with previous research on HANK models, which focused on frameworks where agents were not allowed to borrow, and which found negligible effects of forward guidance.

Suggested Citation

  • Francesco Ferrante & Matthias Paustian, 2019. "Nominal Debt and the Heterogeneous Effects of Forward Guidance," 2019 Meeting Papers 1256, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:1256
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    References listed on IDEAS

    as
    1. Carlstrom, Charles T. & Fuerst, Timothy S. & Paustian, Matthias, 2015. "Inflation and output in New Keynesian models with a transient interest rate peg," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 230-243.
    2. Greg Kaplan & Giovanni L. Violante & Justin Weidner, 2014. "The Wealthy Hand-to-Mouth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 48(1 (Spring), pages 77-153.
    3. Iván Werning, 2015. "Incomplete Markets and Aggregate Demand," NBER Working Papers 21448, National Bureau of Economic Research, Inc.
    4. Greg Kaplan & Giovanni L. Violante & Justin Weidner, 2014. "The Wealthy Hand-to-Mouth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 45(1 (Spring), pages 77-153.
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