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  4. October 2019
  5. Optimal Forward Guidance

Optimal Forward Guidance

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Abstract

Optimal forward guidance is the simple policy of keeping interest rates low for some optimally determined number of periods after the liquidity trap ends and moving to normal-times optimal policy thereafter. I solve for the optimal duration in closed form in a new Keynesian model and show that it is close to fully optimal Ramsey policy. The simple rule "announce a duration of half of the trap's duration times the disruption" is a good approximation, including in a medium-scale dynamic stochastic general equilibrium (DSGE) model. By anchoring expectations of Delphic agents (who mistake commitment for bad news), the simple rule is also often welfare-preferable to Odyssean commitment.

Citation

Bilbiie, Florin O. 2019. "Optimal Forward Guidance." American Economic Journal: Macroeconomics, 11 (4): 310-45. DOI: 10.1257/mac.20170335

Additional Materials

JEL Classification

  • D84 Expectations; Speculations
  • E12 General Aggregative Models: Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
  • E43 Interest Rates: Determination, Term Structure, and Effects
  • E52 Monetary Policy
  • E58 Central Banks and Their Policies
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