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

Illing, Gerhard and Siemsen, Thomas (9. February 2015): Forward Guidance at the Zero Lower Bound in a Model of Price-Level Targeting. Discussion Papers in Economics 2015-1

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.

• Item Type: Paper
• Keywords: zero lower bound, forward guidance, price-level target, optimal policy
• Faculties: Economics; Economics > Munich Discussion Papers in Economics
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: E43, E52, E58
• Language: English

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