Discussion Paper Series 2022-E-6

Credible Forward Guidance

Taisuke Nakata, Takeki Sunakawa

How can the central bank credibly implement a "lower-for-longer" strategy? To answer this question, we analyze a series of optimal sustainable policy problems - indexed by the duration of reputational loss - in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates. We find that, even without an explicit commitment technology, the central bank can still credibly keep the policy rate at the ELB for an extended period - though not as extended as under the optimal commitment policy - and meaningfully mitigate the adverse effects of the ELB constraint on economic activity.

Keywords: Average Inflation Targeting; Effective Lower Bound; Forward Guidance; Sustainable Plan; Time-Consistency

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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