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A Time-Invariant Duration Policy under the Zero Lower Bound

  • Kozo Ueda

    (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: kouzou.ueda boj.or.jp))

Optimal commitment policy under the zero lower bound entails a high degree of complexity and time-inconsistency in a stochastic economy. This paper proposes a time-invariant duration policy that mitigates those problems and facilitates policy implementation and communication while retaining effectiveness in inflation stabilization. Under the time- invariant duration policy, a central bank commits itself to maintaining low interest rates for some duration even after adverse shocks disappear, but unlike the optimal commitment policy, the duration is independent of the ex post spell of the adverse shocks. Consequently, the time- inconsistency problem does not increase even if the ex post spell of the adverse shocks lengthens, and policy rates are expressed in an extremely simple, explicit form. Simulation results suggest that the time-invariant duration policy performs virtually as effectively as the optimal commitment policy in stabilizing inflation, and far better than a discretionary policy and simple interest rate rules with or without inertia.

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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 10-E-12.

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Date of creation: Jul 2010
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Handle: RePEc:ime:imedps:10-e-12
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  1. Andrew Levin & David López-Salido & Edward Nelson & Yack Yun, 2010. "Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound," International Journal of Central Banking, International Journal of Central Banking, vol. 6(1), pages 143-189, March.
  2. Kato, Ryo & Nishiyama, Shin-Ichi, 2005. "Optimal monetary policy when interest rates are bounded at zero," Journal of Economic Dynamics and Control, Elsevier, vol. 29(1-2), pages 97-133, January.
  3. David 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.).
  4. Adam, Klaus & Billi, Roberto M., 2005. "Discretionary monetary policy and the zero lower bound on nominal interest rates," CFS Working Paper Series 2005/16, Center for Financial Studies (CFS).
  5. Ernst Schaumburg & Andrea Tambalotti, 2003. "An investigation of the gains from commitment in monetary policy," Staff Reports 171, Federal Reserve Bank of New York.
  6. 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.
  7. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc.
  8. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June.
  9. Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics.
  10. Kurozumi, Takushi, 2008. "Optimal sustainable monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1277-1289, October.
  11. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2007. "Unconditionally Optimal Monetary Policy," CDMA Working Paper Series 200721, Centre for Dynamic Macroeconomic Analysis.
  12. Fujiki, Hiroshi & Shiratsuka, Shigenori, 2002. "Policy Duration Effect under the Zero Interest Rate Policy in 1999-2000: Evidence from Japan's Money Market Data," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(1), pages 1-31, January.
  13. 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.
  14. Jensen, Christian & McCallum, Bennett T., 2002. "The non-optimality of proposed monetary policy rules under timeless perspective commitment," Economics Letters, Elsevier, vol. 77(2), pages 163-168, October.
  15. Ippei Fujiwara & Nao Sudo & Yuki Teranishi, 2010. "The Zero Lower Bound and Monetary Policy in a Global Economy: A Simple Analytical Investigation," International Journal of Central Banking, International Journal of Central Banking, vol. 6(1), pages 103-134, March.
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