Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/96847
Authors: 
Illing, Gerhard
Siemsen, Thomas
Year of Publication: 
2014
Series/Report no.: 
CESifo Working Paper 4702
Abstract: 
In this paper we present a three period setup to model central bank forward guidance in a liquidity trap. We analyze the role of long-run and short-run price stickiness under discretion and commitment in a straightforward and intuitive way. Despite the impact of price rigidity on welfare being non-linear, losses under discretion are lowest with perfectly flexible prices. We show why the zero lower bound may still be binding even long after the shock has gone and characterize conditions when a commitment to hold nominal rates at zero for an extended period is optimal. We then introduce government spending and show that under persistently low policy rates optimal government spending becomes more front-loaded, while procyclical austerity fares worse than discretionary government spending.
Subjects: 
zero lower bound
forward guidance
commitment
optimal policy
JEL: 
E43
E52
E58
Document Type: 
Working Paper

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