Optimal Forward Guidance
Florin O. Bilbiie
- American Economic Journal: Macroeconomics (Forthcoming)
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 trapís duration times the disruption" is a good approximation, including in a medium-scale 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.
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