This article assesses the importance of the zero lower bound on nominal interest rates for the conduct of monetary policy. The article employs a small, forward-looking model developed by Fuhrer and Moore. The model is simulated under several policy rules that involve either high- or low-inflation targets. We determine the extent to which the zero bound on nominal interest rates prevents real interest rates from falling in response to negative spending shocks, and thus cushioning aggregate output, when zero inflation results in low nominal rates. ; In general, the results suggest that real long-term interest rates drop considerably in response to an adverse spending shock under a variety of policy rules and inflation rates. The extent of the decline in long real rates, and thus the ability of monetary policy to cushion such shocks, generally depends to only a modest extent on the level of inflation. For relatively small and short-lived spending shocks, as well as for permanent and large shocks, the path of output in the zero inflation case is only a little below that in the higher inflation. But for large shocks persisting a few quarters, differences in output paths across high- and low-inflation scenarios can be larger. ; Without a doubt, these results are somewhat model-specific, and their real-world implications depend on how quickly a central bank can recognize shocks and how vigorously it can respond to them. Moreover, in situations when the zero bound on nominal interest rates does limit the ability of the central bank to stimulate the economy by reducing interest rates, other policy tools--such as fiscal policy may still be effective. Nonetheless, this research suggests that the constraint on monetary policy posed by the zero bound is an issue that merits careful thought and perhaps further investigation in alternative model settings.
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
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number
94-1.
Length: Date of creation: 1994 Date of revision: Publication status: Published in Review of Economics and Statistics 79 (November 1997): 573-85. Handle: RePEc:fip:fedbwp:94-1
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.:
Cited by: (explanations, 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.) This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.