Imperfect Credibility And The Zero Lower Bound On The Nominal Interest Rate
When the nominal interest rate reaches its zero lower bound, credibility is crucial for conducting forward guidance. The authors determine optimal policy in a New Keynesian model when the central bank has imperfect credibility and cannot set the nominal interest rate below zero. In their model, an announcement of a low interest rate for an extended period does not necessarily reflect high credibility. Even if the central bank does not face a temptation to act discretionarily in the current period, policy commitments should not be postponed. In reality, central banks are often reluctant to allow a recovery path with output and inflation temporarily above target.