IDEAS home Printed from https://ideas.repec.org/p/fip/fedfap/94-06.html
   My bibliography  Save this paper

Monetary policy when interest rates are bounded at zero

Author

Listed:
  • Jeff Fuhrer
  • Brian Madigan

Abstract

This article assesses the importance of the zero lower bound on nominal interest rates for the conduct of monetary policy. The article employs a small, forward-looking model developed by Fuhrer and Moore. The model is simulated under several policy rules that involve either high or low inflation targets. We determine the extent to which the zero bound on nominal interest rates prevents real interest rates from falling in response to negative spending shocks, and thus cushioning aggregate output, when zero inflation results in low nominal rates. In general, the results suggest that real long-term interest rates drop considerably in response to an adverse spending shock under a variety of policy rules and inflation rates. The extent of the decline in long real rates, and thus the ability of monetary policy to cushion such shocks, generally depends to only a modest extent on the level of inflation. For relatively small and short-lived spending shocks, as well as for permanent and large shocks, the path of output in the zero inflation case is only a little below that in the higher inflation. But for large shocks persisting a few quarters, differences in output paths across high- and low-inflation scenarios can be larger. Without a doubt, these results are somewhat model-specific, and their real-world implications depend on how quickly a central bank can recognize shocks and how vigorously it can respond to them. Moreover, in situations when the zero bound on nominal interest rates does limit the ability of the central bank to stimulate the economy by reducing interest rates, other policy tools-such as fiscal policy-may still be effective. Nonetheless, this research suggests that the constraint on monetary policy posed by the zero bound is an issue that merits careful thought and perhaps further investigation in alternative model settings.

Suggested Citation

  • Jeff Fuhrer & Brian Madigan, 1994. "Monetary policy when interest rates are bounded at zero," Working Papers in Applied Economic Theory 94-06, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfap:94-06
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    References listed on IDEAS

    as
    1. David E. Lebow, 1993. "Monetary policy at near-zero interest rates," Working Paper Series / Economic Activity Section 136, Board of Governors of the Federal Reserve System (U.S.).
    2. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    3. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
    Full references (including those not matched with items on IDEAS)

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedfap:94-06. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federal Reserve Bank of San Francisco Research Library). General contact details of provider: http://edirc.repec.org/data/frbsfus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.