Gaëtan Fournier : gaetan.fournier[at]univ-amu.fr
Raghul Venkatesh : raghul.venkatesh[at]univ-amu.fr
We propose a tractable New Keynesian model with an overlapping generations structure that offers a resolution to the forward guidance puzzle. Two elements contribute to making the economy less sensitive to future interest rate cuts. First, since households have to save for retirement, a low equilibrium real interest rate is consistent with a higher rate of time preference than in standard New Keynesian models, thereby weakening the strength of the intertemporal substitution channel. Second, and more importantly, forward guidance shocks benefit disproportionately to young generations, notably those who are about to enter the labor market at the time of the announcement. These heterogeneous effects of forward guidance reduce the strength of general equilibrium forces which, in standard models, amplify the initial response of the economy to the shock.