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.
This paper has been prepared for the Carnegie-Rochester Conference Series on Public Policy honoring the contributions of Charles Plosser to Economics.We thank Jeff Lacker for many detailed comments. We gratefully acknowledge financial support from the National Science Foundation Grant No. SES-1357903, FRIPRO Grant No. 250617, the European Research Council ERC Starting Grant 759482, and the Ragnar Soderbergs stiftelse. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Marcus Hagedorn & Jinfeng Luo & Iourii Manovskii & Kurt Mitman, 2019. "Forward Guidance," Journal of Monetary Economics, . citation courtesy of