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We propose a novel framework where forward guidance (FG) is endogenously determined. Our model assumes that a monetary authority solves an optimal policy problem. FG derives from two sources: (1) from commiting to keep interest rates low at the exit of the liquidity trap, to stabilize inflation today; and (2) from debt sustainability concerns. Our model is tractable and admits an analytical solution for interest rates in which (1) and (2) show up as separate arguments that enter additively to the standard Taylor rule. In the case where optimal policy reflects debt sustainability concerns (satises the consolidated budget) monetary policy becomes subservient to fiscal policy. We embed our theory into a DSGE model and estimate it with US data. Our findings suggest that FG during the Great Recession may have partly reflected debt sustainability concerns, but more likely policy reflected a strong commitment to stabilize in inflation and the output gap. Our quantitative findings are thus broadly consistent with the view that the evolution of debt aggregates may have had an impact on monetary policy in the Great Recession, but this impact is likely to be small.
