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Federal Reserve Bank of Dallas
Working Papers
Forward guidance and the state of the economy
Benjamin D. Keen
Alexander W. Richter
Nathaniel Throckmorton
Abstract

This paper examines forward guidance using a nonlinear New Keynesian model with a zero lower bound (ZLB) constraint on the nominal interest rate. Forward guidance is modeled with news shocks to the monetary policy rule. The effectiveness of forward guidance depends on the state of the economy, the speed of the recovery, the ZLB constraint, the degree of uncertainty, the monetary response to inflation, the size of the news shocks, and the forward guidance horizon. Specifically, the stimulus from forward guidance falls as the economy deteriorates or as households expect a slower recovery. When the ZLB binds, less uncertainty about the economy or an expectation of a stronger response to inflation reduces the benefit of forward guidance. Forward guidance via a news shock is less stimulative than an unanticipated monetary policy shock around the steady state, but a news shock is more stimulative near the ZLB and always has a larger cumulative effect on output. When the central bank extends the forward guidance horizon, the cumulative effect initially increases but then decreases. These results indicate that there are limits to the stimulus forward guidance can provide, but that stimulus is largest when the news is communicated early in a recession.


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Benjamin D. Keen & Alexander W. Richter & Nathaniel Throckmorton, Forward guidance and the state of the economy, Federal Reserve Bank of Dallas, Working Papers 1612, 08 Nov 2016, revised 19 May 2016.
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Note: Published as: Keen, Benjamin D., Alexander W. Richter and Nathaniel A. Throckmorton (2017), "Forward Guidance and the State of the Economy," Economic Inquiry 55 (4): 1593-1624.
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Subject headings:
Keywords: Forward guidance; zero lower bound; news shocks; global solution method
DOI: 10.24149/wp1612
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