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The zero lower bound and the dual mandate

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  • William T. Gavin
  • Benjamin D. Keen

Abstract

This article uses a DSGE framework to evaluate the role of monetary policy in determining the likelihood of encountering the zero lower bound. We find that the probability of experiencing episodes of being at zero lower bound depends almost exclusively on the monetary policy rule. A policy rule, such as the one proposed by Taylor (1993) which is based on the dual mandate is highly likely to lead to episodes of zero short-term interest rates if the central bank is not committed to its inflation target. Our results on nominal interest rate and inflation dynamics do not depend on the particular mechanism that makes monetary policy have real effects. The key and necessary assumption is that expectations are forward looking. The bottom line in models in which monetary policy can influence the real economy is that a central bank must be committed to a long-run average-inflation objective if it wishes to achieve a dual mandate while avoiding the zero lower bound.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-026.

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Date of creation: 2012
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Handle: RePEc:fip:fedlwp:2012-026

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Keywords: Interest rates ; Monetary policy;

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References

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  1. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  2. Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers.
  3. Susan Black & William T. Gavin, 1990. "Price stability and the Swedish monetary experiment," Economic Commentary, Federal Reserve Bank of Cleveland, issue Dec.
  4. James B. Bullard & Steven Russell, 2004. "How costly is sustained low inflation for the U.S. economy?," Review, Federal Reserve Bank of St. Louis, issue May, pages 35-68.
  5. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2005. "The monetary instrument matters," Working Papers 2004-026, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Levine, Paul & Pearlman, Joseph, 2011. "Computation of LQ Approximations to Optimal Policy Problems in Different Information Settings under Zero Lower Bound Constraints," Dynare Working Papers 10, CEPREMAP.
  2. William T. Gavin & Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "Global Dynamics at the Zero Lower Bound," Auburn Economics Working Paper Series auwp2013-17, Department of Economics, Auburn University.
  3. Paul Levine & Joseph Pearlman & Bo Yang, 2012. "Imperfect Information, Optimal Monetary Policy and Informational Consistency," School of Economics Discussion Papers 1012, School of Economics, University of Surrey.

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