State-dependent Forward Guidance and the Problem of Inconsistent Announcements

Produced by: 
Banco de la República de Colombia
Available from: 
February 2018
Paper author(s): 
Julian A. Parra-Polania
Institutions and Development
Politics and Economy

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, taking full credibility as given, 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.


Research section: 
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