Forward Guidance with Preferences over Safe Assets

I show that preferences over safe assets (POSA), calibrated by targeting estimates of the wedge between household discount and market interest rates and the effect of the supply of government bonds on their yields, attenuate the of effect forward guidance in a New Keynesian model, by reducing consumption’s responsiveness to future interest rates and generating a wealth effect from real government bond holdings. The attenuation carries over to a medium-scale model with POSA estimated on Euro Area macroeconomic, fiscal and interest-rate expectation data. The empirical fit of the POSA model strongly outperforms an otherwise identical model without POSA.