Monetary policy when interest rates are bounded at zero
AbstractThis 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.
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Bibliographic InfoPaper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 94-06.
Date of creation: 1994
Date of revision:
Publication status: Published in Conference on Monetary Policy in a Low Inflation Regime
Other versions of this item:
- Jeffrey C. Fuhrer & Brian F. Madigan, 1997. "Monetary Policy When Interest Rates Are Bounded At Zero," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 573-585, November.
- Jeffrey Fuhrer & Brian Madigan, 1994. "Monetary policy when interest rates are bounded at zero," Working Papers 94-1, Federal Reserve Bank of Boston.
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.:
- David E. Lebow, 1993. "Monetary policy at near-zero interest rates," Working Paper Series / Economic Activity Section 136, Board of Governors of the Federal Reserve System (U.S.).
- Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
- Taylor, John B, 1980.
"Aggregate Dynamics and Staggered Contracts,"
Journal of Political Economy,
University of Chicago Press, vol. 88(1), pages 1-23, February.
Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Bernanke: Monetary Policy and the Housing Bubble
by Mark Thoma in Economist's View on 2010-01-03 20:06:00
- Monetary Policy and the Housing Bubble
by Guest Author in the big picture on 2010-01-04 11:00:02
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