Threshold-based forward guidance
Published in Journal of Economic Dynamics and Control, 2018
(with Lena Boneva and Matt Waldron)
When the monetary policy rate is at the zero bound, “threshold-based forward guidance” (TBFG) is a state-contingent promise to delay liftoff from the zero bound until macroeconomic variables breach particular “thresholds”. We study TBFG within a stochastic version of the workhorse New Keynesian model. We show that TBFG can be used to provide temporary stimulus, while also limiting the time inconsistency of policy promises. Existence of a unique equilibrium requires the policymaker to specify how the thresholds should be interpreted, as well as their values. With an appropriate choice of thresholds, TBFG outperforms forward guidance based purely on calendar time and substantially reduces welfare losses compared to the optimal time-consistent policy.