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Endogenous volatility at the zero lower bound: implications for stabilization policy

Listed author(s):
  • Basu, Susanto
  • Bundick, Brent

    ()

    (Federal Reserve Bank of Kansas City)

At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.

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File URL: http://www.kansascityfed.org/publicat/reswkpap/pdf/rwp15-01.pdf
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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 15-1.

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Length: 51 pages
Date of creation: 01 Jan 2015
Handle: RePEc:fip:fedkrw:rwp15-01
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