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Monetary Policy Lag, Zero Lower Bound, and Inflation Targeting

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Author Info
Shin-Ichi Nishiyama
Abstract

Although the concept of monetary policy lag has historical roots deep in the monetary economics literature, relatively little attention has been paid to the idea. In this paper, we build on Svensson’s (1997) inflation targeting framework by explicitly taking into account the lagged effect of monetary policy and characterize the optimal monetary policy reaction function both in the absence and in the presence of the zero lower bound on the nominal interest rate. We numerically show the function to be more aggressive and more pre-emptive with the lagged effect than without it. We also characterize the long-run stabilization cost to the central bank by explicitly taking into account the lagged effect of monetary policy. It turns out that, in the presence of the zero lower bound constraint, the long-run stabilization cost is higher with the lagged effect than the case without it. This result suggests that the central bank and/or the government should set a relatively high inflation target when confronted with a relatively long monetary policy lag. This can be interpreted as another justification for targeting a positive inflation rate in the long-run.

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Paper provided by Bank of Canada in its series Working Papers with number 09-2.

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Length: 40 pages
Date of creation: 2009
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Handle: RePEc:bca:bocawp:09-2

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Related research
Keywords: Inflation targets; Monetary policy framework; Monetary policy implementation;

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
C63 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computational Techniques

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References listed on IDEAS
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  15. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada. [Downloadable!]
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  19. Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-35, October.
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  21. Günter Coenen & Athanasios Orphanides & Volker Wieland, 2004. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," The B.E. Journal of Macroeconomics, Berkeley Electronic Press, vol. 0(1). [Downloadable!]
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  22. Sack, Brian & Wieland, Volker, 2000. "Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 205-228. [Downloadable!] (restricted)
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  23. Amato, Jeffery D. & Laubach, Thomas, 2004. "Implications of habit formation for optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 305-325, March. [Downloadable!] (restricted)
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