Risk Premium Shocks and the Zero Bound on Nominal Interest Rates
AbstractThere 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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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 09-27.
Length: 40 pages
Date of creation: 2009
Date of revision:
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Other versions of this item:
- Robert Amano & Malik Shukayev, 2012. "Risk Premium Shocks and the Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(8), pages 1475-1505, December.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-17 (All new papers)
- NEP-CBA-2009-10-17 (Central Banking)
- NEP-DGE-2009-10-17 (Dynamic General Equilibrium)
- NEP-MAC-2009-10-17 (Macroeconomics)
- NEP-MON-2009-10-17 (Monetary Economics)
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