2024 European Winter Meeting, Palma de Majorca, Spain: December, 2024
Higher-Order Forward Guidance
Marc Dordal i Carreras, Seung Joo Lee
This paper presents a business cycle model that incorporates financial markets and endogenous financial volatility at the Zero Lower Bound (ZLB). We uncover three key insights: (i) Central banks can reduce excess financial volatility at the ZLB by credibly committing to future economic stabilization; (ii) Alternatively, a commitment to refrain from future stabilization can guide the economy towards more favorable equilibrium paths, highlighting a trade-off between future stabilization and reduced financial volatility at the ZLB; (iii) Maintaining some uncertainty about the timing of future stabilization is strictly superior to other forms of forward guidance commitments.
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