Attenuating the Forward Guidance Puzzle: Implications for Optimal Monetary Policy
47 Pages Posted: 14 Jan 2019
Date Written: January 11, 2019
We examine the implications of less powerful forward guidance for optimal policy using a sticky-price model with an eﬀective lower bound (ELB) on nominal interest rates as well as a discounted Euler equation and Phillips curve. When the private-sector agents discount future economic conditions more in making their decisions today, an announced cut in future interest rates becomes less eﬀective in stimulating current economic activity. While the implication of such discounting for optimal policy depends on its degree, we ﬁnd that, under a wide range of plausible degrees of discounting, it is optimal for the central bank to compensate for the reduced eﬀect of a future rate cut by keeping the policy rate at the ELB for longer.
Keywords: forward guidance, optimal policy, discounted euler equation, discounted phillips curve, eﬀective lower bound
JEL Classification: E52, E58, E61
Suggested Citation: Suggested Citation