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Risk Premium Shocks and the Zero Bound on Nominal Interest Rates

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  • ROBERT AMANO
  • MALIK SHUKAYEV

Abstract

There appears to be a disconnect between the importance of the zero bound on nominal interest rates in the real-world and predictions from quantitative DSGE models. Recent economic events have reinforced the relevance of the zero bound for monetary policy whereas quantitative models suggest that the zero bound does not constrain (optimal) monetary policy. This paper attempts to shed some light on this disconnect by studying a broader range of shocks within a standard DSGE model. Without denying the possibility of other factors, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. The risk premium mechanism operates by increasing the spread between the rates of return on private capital and risk-free government bonds. Other common shocks, such as aggregate productivity, investment-specific productivity, government spending and money demand shocks, are unable to push nominal bond rates close to zero as the same risk premium spread mechanism is not at play.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00541.x
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Bibliographic Info

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

Volume (Year): 44 (2012)
Issue (Month): 8 (December)
Pages: 1475-1505

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:8:p:1475-1505

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

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Cited by:
  1. Yuriy Gorodnichenko & Johannes Wieland & Olivier Coibion, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," 2012 Meeting Papers 70, Society for Economic Dynamics.
  2. Rossana MEROLA, 2012. "Monetary policy and fiscal stimulus with the zero lower bound and financial frictions," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2012024, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  3. J. A. Carrillo & C. Poilly, 2012. "How do financial frictions affect the spending multiplier during a liquidity trap?," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 12/779, Ghent University, Faculty of Economics and Business Administration.
  4. Christopher M. Gunn & Alok Johri, 2010. "An Expectations-Driven Interpretation of the "Great Recession"," Carleton Economic Papers 13-02, Carleton University, Department of Economics, revised 22 Feb 2013.
  5. Julio Carrillo & Celine Poilly, 2013. "Online Appendix to "How do financial frictions affect the spending multiplier during a liquidity trap?"," Technical Appendices 12-54, Review of Economic Dynamics.
  6. Christopher M. Gunn & Alok Johri, 2012. "News, Credit Spreads and Default Costs: An expectations-driven interpretation of the recent boom-bust cycle in the U.S," Department of Economics Working Papers 2012-04, McMaster University.

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