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Are nonlinear methods necessary at the zero lower bound?

Author

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  • Richter, Alexander W.

    () (Federal Reserve Bank of Dallas)

  • Throckmorton, Nathaniel

    (College of William & Mary)

Abstract

This paper examines the importance of the zero lower bound (ZLB) constraint on the nominal interest rate by estimating three variants of a small-scale New Keynesian model: (1) a nonlinear model with an occassionally binding ZLB constraint; (2) a constrained linear model, which imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model, which never imposes the constraint. The posterior distributions are similar, but important differences arise in their predictions at the ZLB. The nonlinear model fits the data better at the ZLB and primarily attributes the ZLB to a reduction in household demand due to discount factor shocks. In the linear models, the ZLB is due to large contractionary monetary policy shocks, which is at odds with the Fed’s expansionary policy during the Great Recession. Posterior predictive analysis shows the nonlinear model is partially able to account for the increase in output volatility and the negative skewness in output and inflation that occurred during the ZLB period, whereas the linear models predict almost no changes in those statistics. We also compare the results from our nonlinear model to the quasi-linear solution based on OccBin. The quasi-linear model fits the data better than the linear models, but it still generate too little volatility at the ZLB and predicts that a large policy shock caused the ZLB to bind in 2008Q4.

Suggested Citation

  • Richter, Alexander W. & Throckmorton, Nathaniel, 2016. "Are nonlinear methods necessary at the zero lower bound?," Working Papers 1606, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddwp:1606
    DOI: 10.24149/wp1606
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    File URL: http://www.dallasfed.org/assets/documents/research/papers/2016/wp1606.pdf
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    References listed on IDEAS

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    Cited by:

    1. Lansing, Kevin J., 2017. "Endogenous Regime Switching Near the Zero Lower Bound," Working Paper Series 2017-24, Federal Reserve Bank of San Francisco.
    2. repec:bla:ecinqu:v:55:y:2017:i:4:p:1593-1624 is not listed on IDEAS
    3. Jesper Lindé & Mathias Trabandt, 2017. "Should We Use Linearised Models to Calculate Fiscal Multipliers?," European Economy - Discussion Papers 2015 - 064, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    4. Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2017. "Forward Guidance And The State Of The Economy," Economic Inquiry, Western Economic Association International, vol. 55(4), pages 1593-1624, October.
    5. Hirokuni Iiboshi & Mototsugu Shintani & Kozo Ueda, 2018. "Estimating a Nonlinear New Keynesian Model with a Zero Lower Bound for Japan," Working Papers e120, Tokyo Center for Economic Research.

    More about this item

    Keywords

    Bayesian estimation; model comparison; zero lower bound; particle filter;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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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