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Note on zero lower bound worries

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  • Cees Ullersma
  • Gerben Hieminga
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    Abstract

    Although some authors have suggested that monetary expansion is still possible when the monetary policy interest rate cannot be reduced further, central banks tend to avoid interest rates close to the zero lower bound. Taking into account central banks.aversion to very low interest rates, we investigate optimal monetary policy in a New-Keynesian macro-economic model. Our analysis shows that appointing a central banker with a high aversion to low interest rate levels can mitigate the zero bound risk at the cost of persistent in.ation deviations from target. If fear of the zero lower bound is unfounded, it is better to appoint a central banker with no aversion to the zero lower bound, who will not shy away from unorthodox policies when the policy interest rate cannot be reduced further.

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    File URL: http://www.dnb.nl/binaries/Working%20Paper%20117-2006_tcm46-146774.pdf
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    Bibliographic Info

    Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 117.

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    Date of creation: Oct 2006
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    Handle: RePEc:dnb:dnbwpp:117

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    Keywords: zero lower bound; inflation bias.;

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    1. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    2. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
    3. Svensson, Lars E O, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," CEPR Discussion Papers 2566, C.E.P.R. Discussion Papers.
    4. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap," IMF Working Papers 03/64, International Monetary Fund.
    5. Ben S. Bernanke & Vincent R. Reinhart, 2004. "Conducting Monetary Policy at Very Low Short-Term Interest Rates," American Economic Review, American Economic Association, vol. 94(2), pages 85-90, May.
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