American Economic Journal: Macroeconomics
no. 4, October 2019
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.
Bilbiie, Florin O.
"Optimal Forward Guidance."
American Economic Journal: Macroeconomics,
General Aggregative Models: Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
Interest Rates: Determination, Term Structure, and Effects
Central Banks and Their Policies