Optimal nominal interest rates rule are usually set assuming that the underlying world is linear. Our work relaxes this assumption and examines the performance of optimal rules when non-linearities are present. In particular if the inflation-output trade off exhibits non linearities (convexities) this will impart a bias to inflation when a linear rule is used. To correct this bias we propose a piecewise linear rule, which can be thought of as an approximation to the non- linear rule of Schaling (1999). We show that this reduces the bias, but at the expense of an increase in the volatility of the nominal interest rate. Finally we examine how the zero floor on nominal interest rate affects output and inflation when both rules are adopted. With a linear feedback rule the output variability increases since nominal interest rate cannot be further reduced in presence of adverse shocks. The adoption of a piecewise rule with a zero floor on interest rates successfully reduces output volatility. Significant differences in the transmission mechanism of monetary policy, between the USA and the UK, show up both in the form of the optimal feedback rule and in the distribution of outcomes when there is a zero floor to nominal interest rates and non-linearities in the Phillips curve.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Find related papers by JEL classification: C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.: