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Deflationary shocks and monetary rules: an open-economy scenario analysis

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  • Douglas Laxton
  • Papa N'Diaye
  • Paolo Pesenti

Abstract

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions about whether the zero interest rate floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy relative to the rest of the world. Negative demand shocks have more prolonged and conspicuous effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. Economies that are more open hit the ZIF for a shorter period of time, and with less harmful effects. The implications of deflationary supply shocks depend on whether the shocks are concentrated in the tradables or the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 267.

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Date of creation: 2006
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Handle: RePEc:fip:fednsr:267

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Keywords: Economic forecasting ; Monetary policy ; Interest rates ; Macroeconomics;

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References

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  1. Fumio Hayashi & Edward C. Prescott, 2000. "The 1990s in Japan: a lost decade," Working Papers 607, Federal Reserve Bank of Minneapolis.
  2. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc.
  3. Hamid Faruqee & Douglas Laxton & Dirk Muir & Paolo A. Pesenti, 2007. "Smooth Landing or Crash? Model-Based Scenarios of Global Current Account Rebalancing," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 377-456 National Bureau of Economic Research, Inc.
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Cited by:
  1. Daniel Leigh, 2009. "Monetary Policy and the Lost Decade: Lessons from Japan," IMF Working Papers 09/232, International Monetary Fund.
  2. Malhar Nabar, 2011. "Targets, Interest Rates, and Household Saving in Urban China," IMF Working Papers 11/223, International Monetary Fund.

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