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Limitations On The Effectiveness Of Forward Guidance At The Zero Lower Bound

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Executive Summary

The recent literature on monetary policy in the presence of a zero lower bound on interest rates has shown that forward guidance regarding the path of interest rates can be very effective in preserving macroeconomic stability in the face of a contractionary demand shock; moreover, that literature apparently leaves little scope for any further improvements in stabilization performance via nontraditional monetary policies. In this paper, the authors characterize optimal policy under commitment in a prototypical New Keynesian model and examine whether those conclusions are sensitive to the specification of the shock process and to the interest elasticity of aggregate demand.

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