Credible Forward Guidance

Abstract

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 when the central bank lacks commitment, 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.