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Exchange-rate policy and the zero bound on nominal interest rates

  • Coenen, Günter
  • Wieland, Volker

In this paper, we study the effectiveness of monetary policy in a severe recession and de?ation when nominal interest rates are bounded at zero. We compare two alternative proposals for ameliorating the effect of the zero bound: an exchange-rate peg and price-level targeting. We conduct this quantitative comparison in an empirical macroeconometric model of Japan, the United States and the euro area. Furthermore, we use a stylized micro-founded two-country model to check our qualitative ?ndings. We ?nd that both proposals succeed in generating in?ationary expectations and work almost equally well under full credibility of monetary policy. However, price-level targeting may be less effective under imperfect credibility, because the announced price-level target path is not directly observable. JEL Classification: E31, E52, E58, E61

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Paper provided by European Central Bank in its series Working Paper Series with number 0350.

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Date of creation: Apr 2004
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Handle: RePEc:ecb:ecbwps:20040350
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  1. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
  2. James Clouse & Dale Henderson & Athanasios Orphanides & David Small & Peter Tinsley, 2000. "Monetary policy when the nominal short-term interest rate is zero," Finance and Economics Discussion Series 2000-51, Board of Governors of the Federal Reserve System (U.S.).
  3. Coenen, Günter & Wieland, Volker, 2003. "The Zero-Interest Rate Bound and the Role of the Exchange Rate for Monetary Policy in Japan," CEPR Discussion Papers 3895, C.E.P.R. Discussion Papers.
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  6. Volker Wieland (Goethe University Frankfurt) & Günter Coenen (European Central Bank), 2004. "Exchange Rate Policy and the Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 65, Society for Computational Economics.
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  23. Douglas Laxton & Eswar Prasad, 1997. "Possible Effects of European Monetary Unionon Switzerland: A Case Study of Policy Dilemmas Caused by Low Inflation and the Nominal Interest Rate Floor," IMF Working Papers 97/23, International Monetary Fund.
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