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Investigating the Zero Lower Bound on the Nominal Interest Rate under Financial Instability

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  • Carrillo Julio A.
  • Poilly Céline

    (METEOR)

Abstract

This paper introduces a zero lower bound constraint on the nominal interest rate in a financial accelerator model with nominal and real rigidities. We .rst analyze the implicationsfor aggregate dynamics of binding the zero lower bound for shocks that depress the nominalinterest rate. We include a sudden decrease in the value of the business sector net worth and an increase in its returns volatility, as two financial shocks that originate in the endogenous credit market of the model. We then explore the effects of the central bank management of expectations and a fiscal stimulus in a deep recession scenario, where the interest rate initially binds its zero bound. We find that a commitment by the central bank to keep the interest rate low for more time than prescribed by a typical interest rate rule may indeed reduce the volatility of output and inflation. For government purchases, we find a fiscal multiplier greater than one for at least 5 quarters. This is due to the presence of the zero lower bound and the Fisher (1933)’s debt-deflation channel, which implies that government spending may reduce the business sector risk premium and thus the cost of investment.

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Bibliographic Info

Paper provided by Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR) in its series Research Memorandum with number 019.

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Date of creation: 2010
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Handle: RePEc:unm:umamet:2010019

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Keywords: monetary economics ;

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Cited by:
  1. Stefanie Flotho, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Discussion Paper Series, Department of International Economic Policy, University of Freiburg 20, Department of International Economic Policy, University of Freiburg, revised Jun 2012.
  2. Flotho, Stefanie, 2012. "Monetary and Fiscal Policy in a Monetary Union under the Zero Lower Bound constraint," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62028, Verein für Socialpolitik / German Economic Association.

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