Forward guidance

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.

Household Debt and the Heterogeneous Effects of Forward Guidance

“…However, a number of authors have pointed out that the aggregate dynamics in response to future monetary policy shocks in HANK models depend crucially on various auxiliary assumptions, which can either dampen or amplify the power of forward guidance. For example, Werning (2015) and Hagedorn et al (2019) show that the results in MNS are heavily influenced by assumptions on tax progressivity and on the distribution of dividends, which do not bear any consequence in a RANK model. These assumptions imply that, in MNS, forward guidance redistributes resources towards wealthier agents with lower marginal propensity to consume (MPC), which limits the effect on aggregate demand.…”

“…Consequently, quantitative HANK models, in which the wealth distribution is a relevant state variable, can give different answers to the question of whether forward guidance is still a powerful tool in heterogeneous agents frameworks. Hagedorn et al (2019) introduce wage stickiness and nominal government bonds and taxes in their HANK model, in order to minimize the redistributive channels present in MNS, and find that the impact of forward guidance in a liquidity trap is still negligible, even weaker than in MNS. On the other hand, Werning (2015) shows that in a model with extreme market incompleteness, meaning no borrowing and no public debt, forward guidance has the same impact in RANK and HANK models, if individual income moves proportionally to aggregate income.…”

“…The role of household debt positions has received surprisingly little attention in HANK models in the context of forward guidance. 23 In fact, MNS, Hagedorn et al (2019), and Farhi and Werning (2019) use models with a no-borrowing constraint, so that households are savers and the borrower is the government. 4 In our framework, households borrow and lend among each others.…”

“…Our framework is directly comparable with the setting in MNS and it allows for a richer quantitative analysis than the analytical setting in Bilbiie (2019) or Acharya and Dogra (2019). Hagedorn et al (2019) use a quantitative HANK model and maintain the assumption of a zero borrowing limit for households. They depart from MNS along two dimensions.…”

A Business Cycle Model with Neuroeconomic Foundations

“…The literature has offered alternative solutions to some of these puzzles by relying on inattention (Gabaix, 2019(Gabaix, , 2017, limited foresight (García-Schmidt and Woodford, 2019; Woodford, 2019), level-k thinking (Farhi and Werning, 2019), heterogeneous agents (McKay et al, 2016;Hagedorn et al, 2019;Bilbiie, 2019), incomplete information (Wiederholt, 2015;Angeletos and Lian, 2018), the fiscal theory of the price level (Cochrane, 2018), or wealth in the utility function (Michaillat and Saez, 2019), among others. The present paper contributes to this literature by proposing an analytically 3 simpler model motivated by the consumer behavior literature.…”