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Monetary Policy Frameworks and the Effective Lower Bound on Interest Rates

Author

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  • Thomas M. Mertens
  • John C. Williams

Abstract

This paper applies a New Keynesian model to analyze monetary policy in the presence of a low natural rate of interest and a lower bound on interest rates. Under standard inflation-targeting, inflation expectations will be anchored at a level below the inflation target. Two themes emerge from our analysis: first, the central bank can mitigate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework. Second, price-level targeting that raises inflation expectations when inflation is low can both anchor expectations at target and further reduce the effects of the lower bound on the economy.

Suggested Citation

  • Thomas M. Mertens & John C. Williams, 2019. "Monetary Policy Frameworks and the Effective Lower Bound on Interest Rates," AEA Papers and Proceedings, American Economic Association, vol. 109, pages 427-432, May.
    • Handle: RePEc:aea:apandp:v:109:y:2019:p:427-32
    Note: DOI: 10.1257/pandp.20191083
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    References listed on IDEAS

    as
    1. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    2. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    3. Thomas M. Mertens & John C. Williams, 2018. "What to expect from the lower bound on interest rates: evidence from derivatives prices," Staff Reports 865, Federal Reserve Bank of New York.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Cecchetti, Stephen G & Schoenholtz, Kermit, 2019. "Improving U.S. Monetary Policy Communications," CEPR Discussion Papers 13915, C.E.P.R. Discussion Papers.
    2. Jerome H. Powell, 2019. "Monetary Policy: Normalization and the Road Ahead : a speech at the 2019 SIEPR Economic Summit, Stanford Institute of Economic Policy Research, Stanford, California, March 8, 2019," Speech 1044, Board of Governors of the Federal Reserve System (U.S.).
    3. Jerome H. Powell, 2019. "Opening Remarks : a speech at the \\"Conference on Monetary Policy Strategy, Tools, and Communications Practices\\" sponsored by the Federal Reserve, Federal Reserve Bank of Chicago, Chicago," Speech 1070, Board of Governors of the Federal Reserve System (U.S.).
    4. Carl E. Walsh, 2019. "Alternatives to Inflation Targeting in Low Interest Rate Environments," IMES Discussion Paper Series 19-E-13, Institute for Monetary and Economic Studies, Bank of Japan.

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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