Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/249591 
Year of Publication: 
2021
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 11/2021
Publisher: 
Bank of Finland, Helsinki
Abstract: 
We study zero interest-rate policy in response to a large negative demand shock when long-run expectations can fall over time. Because falling expectations make monetary policy less effective by raising real interest rates, the optimal forward guidance policy makes large front-loaded promises to stabilize expectations. Policy is too stimulatory in the event of transitory shocks, but provides insurance against persistent shocks. The optimal policy is well-approximated by a constant calendar-based forward guidance, independent of the shock's realised persistence. The insurance property distinguishes our paper from other bounded rationality papers that solve the forward guidance puzzle and generates important quantitative differences.
Subjects: 
Optimal Monetary Policy
Learning Dynamics
Expectations Stabilization
Forward Guidance
JEL: 
E32
D83
D84
Persistent Identifier of the first edition: 
ISBN: 
978-952-323-384-3
Document Type: 
Working Paper

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