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Forward Guidance at the Zero Lower Bound in a Model of Price-Level Targeting

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  • Illing, Gerhard
  • Siemsen, Thomas

Abstract

We study monetary policy at the ZLB in a traceable three-period model, in which price-level targeting emerges endogenously in the welfare function. We characterize optimal price-level forward guidance under discretion and commitment. Potentially non-monotonic discretionary welfare losses are lowest with perfectly flexible prices. Price-level targeting introduces a new constraint on optimal forward guidance that restricts the credible amount of overshooting. With this constraint, the zero lower bound may be binding even after the shock has abated. We characterize conditions when the commitment to hold nominal rates at zero for an extended period is optimal. Finally, we introduce government spending and show that under persistently low policy rates optimal government spending becomes more front-loaded, while procyclical austerity fares worse than discretionary government spending.

Suggested Citation

  • Illing, Gerhard & Siemsen, Thomas, 2015. "Forward Guidance at the Zero Lower Bound in a Model of Price-Level Targeting," Discussion Papers in Economics 22797, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenec:22797
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    References listed on IDEAS

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    1. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
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    5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    6. John H. Cochrane, 2013. "The New-Keynesian Liquidity Trap," NBER Working Papers 19476, National Bureau of Economic Research, Inc.
    7. Michael Woodford, 2004. "Inflation targeting and optimal monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 86(Jul), pages 15-42.
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    Cited by:

    1. Piotr Fiszeder & Ilona Pietryka, 2018. "Monetary policy in steering the EONIA and POLONIA rates in the Eurosystem and Poland: a comparative analysis," Empirical Economics, Springer, vol. 55(2), pages 445-470, September.

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    More about this item

    Keywords

    zero lower bound; forward guidance; price-level target; optimal policy;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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