Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound

<p>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 non-traditional monetary policies. In this paper we characterize optimal policy under commitment in a prototypical New Keynesian model and examine whether those conclusions are sensitive to the specifiation of the shock process and to the interest elasticity of aggregate demand. Although forward guidance is effective in offsetting natural rate shocks of moderate size and persistence we find that the macroeconomic outcomes are much less appealing for larger and more persistent shocks especially when the interest elasticity parameter is set to values widely used in the literature. Thus while forward guidance could be suffcient for mitigating the effects of a Great Moderation-style shock a combination of forward guidance and other monetary policy measures - such as large-scale asset purchases - might well be called for in responding to a Great Recession-style shock.</p><p>This work has been selected by scholars as being culturally important and is part of the knowledge base of civilization as we know it. This work was reproduced from the original artifact and remains as true to the original work as possible. Therefore you will see the original copyright references library stamps (as most of these works have been housed in our most important libraries around the world) and other notations in the work.</p><p>This work is in the public domain in the United States of America and possibly other nations. Within the United States you may freely copy and distribute this work as no entity (individual or corporate) has a copyright on the body of the work.</p><p>As a reproduction of a historical artifact this work may contain missing or blurred pages poor pictures errant marks etc. Scholars believe and we concur that this work is important enough to be preserved reproduced and made generally available to the public. We appreciate your support of the preservation process and thank you for being an important part of keeping this knowledge alive and relevant.</p>