Essays on Monetary Policy at the Effective Lower Bound and with Financial Disruption
This dissertation consists of three self-contained chapters.
The first chapter analyzes the effectiveness of optimal sustainable forward guidance at the effective lower bound when the economy faces occasional financial disruptions. Financial disruptions make households and firms respond less to future monetary shocks because of precautionary saving and the value of current profit increases. As a result, the following three results emerge. First, forward guidance affects the current economy much less strongly without changing its effect when the economy exits the lower bound. Second, the effectiveness of forward guidance becomes weaker even if the central bank has perfect credibility and commit to stronger forward guidance. Third, since output gaps and inflation experience a larger deviation from the optimal level at exit periods, credibility concerns make the effectiveness of optimal sustainable forward guidance even weaker.
The second chapter analyzes the effectiveness of forward guidance in a low natural rate of interest environment. Since the strength of forward guidance depends on how lower and how many more periods the central bank will set the real interest below the natural rate, a low natural rate environment makes the central bank commit to forward guidance with longer horizons to achieve the same effects on the current period. This increases the cost of forward guidance at the exit periods because the deviation from the optimal level becomes larger and lasts longer. As a result, the effectiveness of forward guidance becomes weaker even if the central bank has perfect credibility. Moreover, gaining credibility becomes harder and this even weakens the effectiveness of forward guidance.
The third chapter analyzes how the effects of monetary policy depend on the condition of the financial sector. With heterogeneous households in terms of the marginal cost of working, there exist essential financial needs. When it is more costly for the financial sector to extend lending than normal times, the effects of monetary policy becomes smaller. The larger the households heterogeneity is, the smaller the effects become. This is in sharp contrast with the case when there are no financial frictions in that the households heterogeneity does not affect the effects of monetary policy with the perfect financial market. The results also hold for forward guidance.