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Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis

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  • Laxton, Doug
  • N'Diaye, Papa
  • Pesenti, Paolo

Abstract

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-à-vis the rest of the world. Negative demand shocks have more prolonged and startling 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. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than 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.

Suggested Citation

  • Laxton, Doug & N'Diaye, Papa & Pesenti, Paolo, 2006. "Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis," CEPR Discussion Papers 5997, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:5997
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    Cited by:

    1. Mr. Malhar S Nabar, 2011. "Targets, Interest Rates, and Household Saving in Urban China," IMF Working Papers 2011/223, International Monetary Fund.
    2. Daniel Leigh, 2010. "Monetary Policy and the Lost Decade: Lessons from Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(5), pages 833-857, August.
    3. Mr. Douglas Laxton & David Rose & Mr. Philippe D Karam & Mr. Dennis P Botman, 2007. "DSGE Modeling at the Fund: Applications and Further Developments," IMF Working Papers 2007/200, International Monetary Fund.
    4. Mr. Daniel Leigh, 2009. "Monetary Policy and the Lost Decade: Lessons from Japan," IMF Working Papers 2009/232, International Monetary Fund.
    5. N'Diaye, Papa & Zhang, Ping & Zhang, Wenlang, 2010. "Structural reform, intra-regional trade, and medium-term growth prospects of East Asia and the Pacific--Perspectives from a new multi-region model," Journal of Asian Economics, Elsevier, vol. 21(1), pages 20-36, February.
    6. Daniel Leigh, 2010. "Monetary Policy and the Lost Decade: Lessons from Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(5), pages 833-857, August.

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    More about this item

    Keywords

    deflation; monetary policy rules; zero interest rate floor;
    All these keywords.

    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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