State-dependent Forward Guidance and the Problem of Inconsistent Announcements

Parra-Polanía, Julián Andrés

State-dependent Forward Guidance and the Problem of Inconsistent Announcements

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Borradores de Economía; No. 1035

Date published

2018-01-30

Date

2018-03-21

Authors

Parra-Polanía, Julián Andrés

Document language

eng

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Las opiniones contenidas en el presente documento son responsabilidad exclusiva de los autores y no comprometen al Banco de la República ni a su Junta Directiva.

The opinions contained in this document are the sole responsibility of the author and do not commit Banco de la República or its Board of Directors.

Abstract

Florez-Jimenez and Parra-Polania (2016) show that unconditional forward guidance (FG) performs poorly except in the most extreme zero lower-bound (ZLB) events and that for any ZLB situation it is better to resort to state-dependent (threshold-based) FG. The model of that paper is solved under the assumption that the threshold (to revert to the optimal discretionary policy) is announced in terms of an exogenous variable (the demand shock). The present paper shows that, when consistency of announcements is not considered, the solution does not change when the threshold is announced in terms of an endogenous variable (output or ináation). However, the paper also illustrates the fact that an endogenous-variable threshold gives rise to inconsistency: the action taken may not conform to the central bank announcement. Consistency imposes limits on the policy rate that can be set since reverting to the optimal discretionary rate can be incompatible with exceeding the threshold.