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Real implications of the zero bound on nominal interest rates

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Alexander L. Wolman

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Abstract

If monetary policy succeeds in keeping average inflation very low, nominal interest rates may occasionally be constrained by the zero lower bound. The degree to which this constraint has real implications depends on the monetary policy feedback rule and the structure of price-setting. Policy rules that make the price level stationary lead to small real distortions from the zero bound. If policy imparts persistence into the inflation rate, the real implications of the zero bound are large in the presence of backward looking price-setting, and small if prices are set to maximize profits.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 03-15.

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Date of creation: 2003
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Handle: RePEc:fip:fedrwp:03-15

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Keywords: Monetary policy Interest rates Price levels

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