Discretionary monetary policy and the zero lower bound on nominal interest rates
Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for th...
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| Published in: | Journal of monetary economics Vol. 54; no. 3; pp. 728 - 752 |
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| Main Authors: | , |
| Format: | Journal Article |
| Language: | English |
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Elsevier B.V
01-04-2007
Elsevier Elsevier Sequoia S.A |
| Series: | Journal of Monetary Economics |
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| Abstract | Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment. |
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| AbstractList | Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment. [PUBLICATION ABSTRACT] Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment. All rights reserved, Elsevier Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with an occasionally binding lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment. |
| Author | Billi, Roberto M. Adam, Klaus |
| Author_xml | – sequence: 1 givenname: Klaus surname: Adam fullname: Adam, Klaus email: klaus.adam@ecb.int organization: CEPR, London and European Central Bank, Directorate General Research, Kaiserstr. 29, 60311 Frankfurt, Germany – sequence: 2 givenname: Roberto M. surname: Billi fullname: Billi, Roberto M. email: roberto.billi@kc.frb.org organization: Federal Reserve Bank of Kansas City, 925 Grand Blvd, Kansas City, MO 64198, USA |
| BackLink | http://econpapers.repec.org/article/eeemoneco/v_3a54_3ay_3a2007_3ai_3a3_3ap_3a728-752.htm$$DView record in RePEc |
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| Keywords | Markov perfect equilibrium E31 E52 Nonlinear optimal policy Occasionally binding constraint Liquidity trap Sequential policy |
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| SubjectTerms | Deflation Equilibrium Inflation Interest rates Keynesian theory Liquidity trap Markov perfect equilibrium Monetary policy Non-linear models Nonlinear optimal policy Occasionally binding constraint Phillips curve Sequential policy Stochastic models Studies U.S.A |
| Title | Discretionary monetary policy and the zero lower bound on nominal interest rates |
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