Working Paper: CEPR ID: DP12559
Authors: Hans Gersbach; Yulin Liu; Martin Tischhauser
Abstract: We examine how forward guidance should be designed when an economy faces negative natural real interest-rate shocks and subsequent supply shocks. Besides a standard approach for forward guidance, we introduce two flexible designs: escaping and switching. With escaping forward guidance, the central banker commits to low interest rates in the presence of negative natural real interest-rate shocks, contingent on a self-chosen inflation rate threshold. With switching forward guidance, the central banker can switch from interest-rate forecasts to inflation forecasts any time in order to stabilize supply shocks. We show that for small and large natural real interest-rate shocks, escaping forward guidance is preferable to any of the other approaches, while switching forward guidance is optimal for intermediate natural real interest-rate shocks. Furthermore, with the polynomial chaos expansion method, we show that our findings are globally robust to parameter uncertainty. In addition, using Sobol’ Indices, we identify the structural parameters with the greatest effect on the results.
Keywords: forward guidance; zero lower bound; central banks; transparency; global robustness; sobol indices; polynomial chaos expansion
JEL Codes: E31; E49; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| escaping forward guidance (E60) | minimizes social losses (D61) |
| switching forward guidance (E61) | stabilizes supply shocks (E63) |
| forward guidance strategies (E61) | impact on inflation expectations (E31) |
| structural parameters (C23) | affect social losses (Z13) |