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Optimal Monetary Policy at the Zero-Interest-Rate Bound

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Author Info
Jung, Taehun
Teranishi, Yuki
Watanabe, Tsutomu

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Abstract

What should a central bank do when faced with a weak aggregate demand even after reducing the short-term nominal interest rate to zero? To address this question, we solve a central bank's intertemporal loss-minimization problem, in which the non-negativity constraint on nominal interest rates is explicitly considered. We find that the optimal path is characterized by policy inertia, in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level. By making such a commitment, the central bank is able to achieve higher expected inflation, lower long-term nominal interest rates, and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady-state level.

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Publisher Info
Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 37 (2005)
Issue (Month): 5 (October)
Pages: 813-35
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Handle: RePEc:mcb:jmoncb:v:37:y:2005:i:5:p:813-35

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June. [Downloadable!]
    Other versions:
  2. Klaus Adam & Roberto M. Billi, 2005. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Research Working Paper RWP 05-07, Federal Reserve Bank of Kansas City. [Downloadable!]
    Other versions:
  3. Mitsuru Iwamara & Takeshi Kudo & Tsutomu Watanabe, 2005. "Monetary and Fiscal Policy in a Liquidity Trap: The Japanese Experience 1999-2004," NBER Working Papers 11151, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Michael Woodford, 2005. "Central Bank Communication and Policy Effectiveness," NBER Working Papers 11898, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Mitsuru Iwamura & Takeshi Kudo & Tsutomu Watanabe, 2005. "Monetary and Fiscal Policy in a Liquidity Trap: The Japanese Experience 1999-2004," Discussion papers 05009, Research Institute of Economy, Trade and Industry (RIETI). [Downloadable!]
  6. R. Anton Braun & Yuichiro Waki, 2005. "Monetary Policy during Japan's Lost Decade," CIRJE F-Series CIRJE-F-343, CIRJE, Faculty of Economics, University of Tokyo. [Downloadable!]
  7. Nobuyuki Oda & Kazuo Ueda, 2005. "The Effects of the Bank of Japan's Zero Interest Rate Commitment and Quantitative Monetary Easing on the Yield Curve: A Macro-Finance Approach," CIRJE F-Series CIRJE-F-336, CIRJE, Faculty of Economics, University of Tokyo. [Downloadable!]
    Other versions:
  8. Shin-Ichi Nishiyama, 2009. "Monetary Policy Lag, Zero Lower Bound, and Inflation Targeting," Working Papers 09-2, Bank of Canada. [Downloadable!]
  9. Mitsuru Iwamura & Takeshi Kudo & Tsutomu Watanabe, 2005. "Monetary and fiscal policy in a liquidity trap: the Japanese experience 1999-2004," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
  10. Klaus Adam & Roberto M. Billi, 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Research Working Paper RWP 05-08, Federal Reserve Bank of Kansas City. [Downloadable!]
    Other versions:
  11. Roberto M. Billi, 2007. "Optimal inflation for the U.S," Research Working Paper RWP 07-03, Federal Reserve Bank of Kansas City. [Downloadable!]
  12. Ernst Juerg Weber, 2007. "The Role of the Real Interest Rate in US Macroeconomic History," Economics Discussion / Working Papers 07-01, The University of Western Australia, Department of Economics. [Downloadable!]
  13. Tomohiro Sugo & Yuki Teranishi, 2008. "The Zero Interest Rate Policy," IMES Discussion Paper Series 08-E-20, Institute for Monetary and Economic Studies, Bank of Japan. [Downloadable!]
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