The Optimal Duration of the Forward Guidance at the Zero Lower Bound

In recent years, the nominal interest rate has hit the zero lower bound, thus limiting the ability of monetary policy to facilitate the real economy’s recovery after a slump. To overcome this problem, many central banks have exploited an instrument based on announcements about the future level of interest rates: the so-called “forward guidance” (FG). Considering a binding zero lower bound (ZLB), we investigate to what extent forward guidance can help economic activity recover when monetary policy is in a liquidity trap. Moreover, relying on a welfare measure, we analyze the optimal duration of forward guidance, i.e., for how many additional periods the central bank should announce future interest rates close to zero.