American Economic Review Vol. 106 No. 10 2016

The Power of Forward Guidance Revisited

Alisdair McKay¹; Emi Nakamura²; Jón Steinsson³

¹ Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215 (email: ) · ² Graduate School of Business, Columbia University, 3022 Broadway, New York, NY 10027 (email: ) · ³ Department of Economics, Columbia University, 420 W 118 Street, New York, NY 10027 (email: )

Abstract

In recent years, central banks have increasingly turned to forward guidance as a central tool of monetary policy. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and these effects grow with the horizon of the forward guidance. We present a model in which the power of forward guidance is highly sensitive to the assumption of complete markets. When agents face uninsurable income risk and borrowing constraints, a precautionary savings effect tempers their responses to changes in future interest rates. As a consequence, forward guidance has substantially less power to stimulate the economy.

DOI

10.1257/aer.20150063

Volume

106

Issue

10

Pages

3133-3158

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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