Working Paper: CEPR ID: DP12858
Authors: Kurt Mitman; Marcus Hagedorn; Iourii Manovskii; Jinfeng Luo
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.
Keywords: forward guidance; monetary policy; incomplete markets
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| forward guidance (E60) | current output (C67) |
| forward guidance (E60) | employment (J68) |
| forward guidance (E60) | forward guidance puzzle (C54) |
| forward guidance puzzle (C54) | current output (C67) |
| forward guidance puzzle (C54) | employment (J68) |