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The Zero Interest Rate Policy

  • Tomohiro Sugo

    (Research and Statistics Department, Bank of Japan (E-mail: tomohiro.sugou @boj.or.jp))

  • Yuki Teranishi

    (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi @boj.or.jp))

This paper derives a generalized optimal interest rate rule that is optimal even under a zero lower bound on nominal interest rates in an otherwise basic New Keynesian model with inflation inertia. Using this optimal rule, we investigate optimal entrance and exit strategies of the zero interest rate policy (ZIP) under the realistic model with inflation inertia and a variety of shocks. The simulation results reveal that the shapes of the entrance and exit strategies in a ZIP change considerably according to the forward- or backward-lookingness of the economy and the size of the shocks. In particular, for large shocks that result in long ZIP periods, the time to the start (end) of the ZIP period is earlier (later) in an economy with inflation inertia than in a purely forward-looking economy. However, these outcomes are surprisingly converse to small shocks that result in short ZIP periods.

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File URL: http://www.imes.boj.or.jp/research/papers/english/08-E-20.pdf
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Paper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 08-E-20.

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Date of creation: Aug 2008
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Handle: RePEc:ime:imedps:08-e-20
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  1. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. Klaus Adam & Roberto M. Billi, 2005. "Optimal monetary policy under commitment with a zero bound on nominal interest rates," Research Working Paper RWP 05-07, Federal Reserve Bank of Kansas City.
  4. David Reifschneider & John C. Williams, 2000. "Three lessons for monetary policy in a low-inflation era," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 936-978.
  5. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
  6. Anton Nakov, 2006. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," Banco de Espa�a Working Papers 0637, Banco de Espa�a.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  8. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc.
  9. Amato, Jeffery D. & Laubach, Thomas, 2003. "Estimation and control of an optimization-based model with sticky prices and wages," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1181-1215, May.
  10. Klaus Adam & Roberto M. Billi, 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Research Working Paper RWP 05-08, Federal Reserve Bank of Kansas City.
  11. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  12. Sugo, Tomohiro & Teranishi, Yuki, 2005. "The optimal monetary policy rule under the non-negativity constraint on nominal interest rates," Economics Letters, Elsevier, vol. 89(1), pages 95-100, October.
  13. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  14. 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.
  15. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
  16. 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.
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