IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Optimal monetary policy under commitment with a zero bound on nominal interest rates

  • Klaus Adam
  • Roberto M. Billi

We determine optimal monetary policy under commitment in a forward-looking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not imply positive average inflation rates in equilibrium. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) mark-up shocks

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.kansascityfed.org/PUBLICAT/RESWKPAP/PDF/RWP05-07.pdf
Download Restriction: no

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 05-07.

as
in new window

Length:
Date of creation: 2005
Date of revision:
Handle: RePEc:fip:fedkrw:rwp05-07
Contact details of provider: Postal:
1 Memorial Drive, Kansas City, MO 64198-0001

Phone: (816) 881-2254
Web page: http://www.kansascityfed.org/

More information through EDIRC

Order Information: Email:


References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Adam, Klaus & Billi, Roberto M, 2004. "Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4585, C.E.P.R. Discussion Papers.
  2. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
  3. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January.
  4. George W. Evans & Seppo Honkapohja, 2003. "Policy Interaction, Expectations and the Liquidity Trap," University of Oregon Economics Department Working Papers 2003-33, University of Oregon Economics Department, revised 06 Jul 2004.
  5. Alan Auerbach & Maurice Obstfeld, 2004. "The Case for Open-Market Purchases in a Liquidity Trap," Macroeconomics 0407009, EconWPA.
  6. Coenen, Guenter & Wieland, Volker, 2003. "The Zero-Interest-Rate and the Role of the Exchange Rate for Monetary Policy in Japan," CFS Working Paper Series 2003/09, Center for Financial Studies (CFS).
  7. David L. Reifschneider & John C. Williams, 1999. "Three lessons for monetary policy in a low inflation era," Finance and Economics Discussion Series 1999-44, Board of Governors of the Federal Reserve System (U.S.).
  8. Jeffrey C. Fuhrer & Brian F. Madigan, 1997. "Monetary Policy When Interest Rates Are Bounded At Zero," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 573-585, November.
  9. Uhlig, H.F.H.V.S., 2000. "Should we be Afraid of Friedman's Rule?," Discussion Paper 2000-62, Tilburg University, Center for Economic Research.
  10. Julio Rotemberg, 1987. "The New Keynesian Microfoundations," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 69-116 National Bureau of Economic Research, Inc.
  11. Peter N. Ireland, 2002. "Technology Shocks in the New Keynesian Model," Boston College Working Papers in Economics 536, Boston College Department of Economics.
  12. Alexander L. Wolman, 2003. "Real implications of the zero bound on nominal interest rates," Working Paper 03-15, Federal Reserve Bank of Richmond.
  13. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
  14. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers 199925, Rutgers University, Department of Economics.
  15. Coenen, Gunter & Wieland, Volker, 2003. "The zero-interest-rate bound and the role of the exchange rate for monetary policy in Japan," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1071-1101, July.
  16. Orphanides, Athanasios, 2004. "Monetary policy in deflation: the liquidity trap in history and practice," The North American Journal of Economics and Finance, Elsevier, vol. 15(1), pages 101-124, March.
  17. Lawrence J. Christiano & Jonas D. M. Fisher, 1994. "Algorithms for solving dynamic models with occasionally binding constraints," Staff Report 171, Federal Reserve Bank of Minneapolis.
  18. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
  19. Adam, Klaus & Billi, Roberto M., 2004. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Working Paper Series 0377, European Central Bank.
  20. Reifschneider, David & Willams, John C, 2000. "Three Lessons for Monetary Policy in a Low-Inflation Era," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 936-66, November.
  21. Ryo Kato & Shinichi Nishiyama, 2001. "Optimal Monetary Policy When Interest Rates are Bound at Zero," Working Papers 01-12, Ohio State University, Department of Economics.
  22. Lawrence H. Summers, 1991. "Panel discussion: price stability ; How should long-term monetary policy be determined?," Proceedings, Federal Reserve Bank of Cleveland, pages 625-631.
  23. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap; Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  24. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  25. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, March.
  26. Willem H. Buiter, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency : Gesell's solution," LSE Research Online Documents on Economics 848, London School of Economics and Political Science, LSE Library.
  27. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
  28. Eggertsson, Gauti B., 2006. "The Deflation Bias and Committing to Being Irresponsible," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 283-321, March.
  29. Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-35, October.
  30. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  31. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
  32. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  33. Evans, George W. & Honkapohja, Seppo, 2003. "Policy Interaction, Expectation and Liquidity Trap," CEPR Discussion Papers 3925, C.E.P.R. Discussion Papers.
  34. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  35. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:fip:fedkrw:rwp05-07. 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: (Lu Dayrit)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 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.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.