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The zero lower bound and the dual mandate

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  • William T. Gavin
  • Benjamin D. Keen

Abstract

This article uses a DSGE framework to evaluate the role of monetary policy in determining the likelihood of encountering the zero lower bound. We find that the probability of experiencing episodes of being at zero lower bound depends almost exclusively on the monetary policy rule. A policy rule, such as the one proposed by Taylor (1993) which is based on the dual mandate is highly likely to lead to episodes of zero short-term interest rates if the central bank is not committed to its inflation target. Our results on nominal interest rate and inflation dynamics do not depend on the particular mechanism that makes monetary policy have real effects. The key and necessary assumption is that expectations are forward looking. The bottom line in models in which monetary policy can influence the real economy is that a central bank must be committed to a long-run average-inflation objective if it wishes to achieve a dual mandate while avoiding the zero lower bound.

Suggested Citation

  • William T. Gavin & Benjamin D. Keen, 2012. "The zero lower bound and the dual mandate," Working Papers 2012-026, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2012-026
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    File URL: http://research.stlouisfed.org/wp/2012/2012-026.pdf
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    References listed on IDEAS

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    1. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    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. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2005. "The monetary instrument matters," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 633-658.
    4. James B. Bullard & Steven Russell, 2004. "How costly is sustained low inflation for the U.S. economy?," Review, Federal Reserve Bank of St. Louis, issue May, pages 35-68.
    5. Charles R. Bean & Matthias Paustian & Adrian Penalver & Tim Taylor, 2010. "Monetary policy after the fall," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 267-328.
    6. Susan Black & William T. Gavin, 1990. "Price stability and the Swedish monetary experiment," Economic Commentary, Federal Reserve Bank of Cleveland, issue Dec.
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    Cited by:

    1. Saten Kumar, 2014. "Financial Crisis, Taylor Rule and the Fed," Working Papers 2014-02, Auckland University of Technology, Department of Economics.
    2. William T. Gavin & Benjamin D. Keen & Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "Global Dynamics at the Zero Lower Bound," Auburn Economics Working Paper Series auwp2013-17, Department of Economics, Auburn University.
    3. Paul Levine & Joseph Pearlman & Bo Yang, 2012. "Imperfect Information, Optimal Monetary Policy and Informational Consistency," School of Economics Discussion Papers 1012, School of Economics, University of Surrey.

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    Keywords

    Interest rates ; Monetary policy;

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