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Title: Forward Guidance

Author(s): Marcus Hagedorn, Jinfeng Luo, Iourii Manovskii and Kurt Mitman

Publication Date: April 2018

Keyword(s): forward guidance, incomplete markets and monetary policy

Programme Area(s): Monetary Economics and Fluctuations

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.

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Bibliographic Reference

Hagedorn, M, Luo, J, Manovskii, I and Mitman, K. 2018. 'Forward Guidance'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=12858