Prolonged low interest rates can be stimulative while leading agents to believe rates will remain lower for longer than central banks intend. When rates rise, however, agents may perceive this as surprise tightening, causing economic contraction. To articulate this unintended effect, this paper develops a New Keynesian model with learning and forward guidance. It finds that prolonged low rates lower agents' perceived nominal neutral rate, and the correction of their belief during rate hikes precipitates economic downturns. Low credibility about forward guidance amplifies this impact. Empirical support is provided by estimating a perceived monetary policy rule using professional forecast data.
Keywords: Low-for-long interest rates; learning; neutral nominal rates; forward guidance; imperfect credibility
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.