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The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates

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  • Roberto M. Billi

    () (- Center for Financial Studies)

Abstract

This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy

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File URL: http://repec.org/sce2005/up.27221.1104375907.pdf
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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 25.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:25

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Keywords: inflation inertia; downward nominal rigidity; nonlinear policy; liquidity trap;

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References

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  1. 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.
  2. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
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Cited by:
  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. Kim, Jinill & Ruge-Murcia, Francisco J., 2007. "How Much Inflation is Necessary to Grease the Wheels?," Cahiers de recherche 2007-10, Universite de Montreal, Departement de sciences economiques.
  3. Roberto M. Billi, 2007. "Optimal inflation for the U.S," Research Working Paper RWP 07-03, Federal Reserve Bank of Kansas City.

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