Forward guidance

Marcus Hagedorn, Jinfeng Luo, Iourii Manovskii, & KurtMitman

Photo: Journal of Monetary Economics

Published in:

Journal of Monetary Economics, Volume 102, April 2019.

DOI: 10.1016/j.jmoneco.2019.01.014

Abstract

We assess the power of forward guidance — promises about future interest rates — as a monetary tool in a liquidity trap using a quantitative incomplete-markets model. Our results suggest the effects of forward guidance are negligible. A commitment to keep future nominal interest rates low for a few quarters—although macro indicators suggest otherwise—has only trivial effects on current output and employment. We explain theoretically why in complete markets models forward guidance is powerful—generating a “forward guidance puzzle”—and why this puzzle disappears in our model. We also clarify theoretically ambiguous conclusions from previous research about the effectiveness of forward guidance in incomplete and complete markets models.

Published July 23, 2019 5:02 PM - Last modified July 23, 2019 5:02 PM