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Forward Guidance Contracts

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  • Liu, Yulin
  • Gersbach, Hans
  • Hahn, Volker

Abstract

We examine "Forward Guidance Contracts", which make central bankers' utility contingent on the precision of interest-rate forecasts. We integrate those contracts into the New Keynesian Framework and study how they can be used to overcome a liquidity trap. We establish the properties of simple renewable Forward Guidance Contracts and characterize the contracts that the government wants to offer repeatedly. These contracts create favorable tradeoffs between the efficacy of forward guidance at the zero bound and the reduced flexibility in reacting to future events, and dominate long-term contracts for moderate negative natural real interest-rate shocks. We discuss which type of Forward Guidance Contracts can be used when there is uncertainty about natural real interest-rate shocks, a situation which typically calls for moderate incentive intensity. Finally we explore alternative contractual environments.

Suggested Citation

  • Liu, Yulin & Gersbach, Hans & Hahn, Volker, 2016. "Forward Guidance Contracts," VfS Annual Conference 2016 (Augsburg): Demographic Change 145552, Verein für Socialpolitik / German Economic Association.
    • Handle: RePEc:zbw:vfsc16:145552
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    References listed on IDEAS

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    Cited by:

    1. Salomon Faure & Hans Gersbach, 2021. "On the money creation approach to banking," Annals of Finance, Springer, vol. 17(3), pages 265-318, September.
    2. Faure, Salomon & Gersbach, Hans, 2016. "Money creation and destruction," CFS Working Paper Series 555, Center for Financial Studies (CFS).
    3. Gersbach, Hans & Liu, Yulin & Tischhauser, Martin, 2021. "Versatile forward guidance: escaping or switching?," Journal of Economic Dynamics and Control, Elsevier, vol. 127(C).
    4. Richhild Moessner & David-Jan Jansen & Jakob de Haan, 2017. "Communication About Future Policy Rates In Theory And Practice: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 31(3), pages 678-711, July.

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    More about this item

    JEL classification:

    • 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
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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