TY  - JOUR
AU  - McKay, Alisdair
AU  - Nakamura, Emi
AU  - Steinsson, Jón
TI  - The Power of Forward Guidance Revisited
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 20882
PY  - 2015
Y2  - January 2015
DO  - 10.3386/w20882
UR  - http://www.nber.org/papers/w20882
L1  - http://www.nber.org/papers/w20882.pdf
N1  - Author contact info:
Alisdair McKay
Federal Reserve Bank of Minneapolis
90 Hennepin Avenue
Minneapolis, MN 55401
Tel: 612/204-5439
E-Mail: alisdair.mckay@gmail.com

Emi Nakamura
Department of Economics
University of California, Berkeley
685 Evans Hall
Berkeley, CA 94720
Tel: 510/643-2104
E-Mail: enakamura@berkeley.edu

Jón Steinsson
Department of Economics
University of California, Berkeley
671 Evans Hall
Berkeley, CA 94720
Tel: 510/642-3674
E-Mail: jsteinsson@berkeley.edu
AB  - In recent years, central banks have increasingly turned to “forward guidance” as a central tool of monetary policy, especially as interest rates around the world have hit the zero lower bound. Standard monetary models imply that far future forward guidance is extremely powerful: promises about far future interest rates have huge effects on current economic outcomes, and these effects grow with the horizon of the forward guidance. We show that the power of forward guidance is highly sensitive to the assumption of complete markets. If 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. In addition, we show that the business cycle dynamics of our incomplete markets model differ substantially from its complete market counterpart. This contrasts with the well-known results of Krusell and Smith (1998). We present approximate representations that can easily be incorporated into standard business cycle models.
ER  -