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Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound

Author

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  • Siddhartha Chattopadhyay

    (Indian Institute of Technology, Kharagpur)

  • Taniya Ghosh

    () (Indira Gandhi Institute of Development Research)

Abstract

Cost channel introduces trade-off between inflation rate and output gap. Unlike the canonical New Keynesian DSGE model, optimal monetary policy cannot set both inflation rate and output gap simultaneously to zero under a demand shock. Using a perfect foresight New Keynesian model with cost channel, this paper analyzes the optimal discretionary monetary policy under Zero Lower Bound (ZLB) for varying degree of interest rate pass-through. We find (i) exit date from ZLB becomes endogenous due to the trade-off between output gap and inflation introduced by the cost channel; (ii) presence of cost channel delays the exit from ZLB compared to models without cost channel; and (iii) exit date rises monotonically with the magnitude of demand shock and degree of interest rate pass-through.

Suggested Citation

  • Siddhartha Chattopadhyay & Taniya Ghosh, 2016. "Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2016-012, Indira Gandhi Institute of Development Research, Mumbai, India.
  • Handle: RePEc:ind:igiwpp:2016-012
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    File URL: http://www.igidr.ac.in/pdf/publication/WP-2016-012.pdf
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    References listed on IDEAS

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    5. 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.
    6. Chowdhury, Ibrahim & Hoffmann, Mathias & Schabert, Andreas, 2006. "Inflation dynamics and the cost channel of monetary transmission," European Economic Review, Elsevier, vol. 50(4), pages 995-1016, May.
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    Cited by:

    1. Lasitha R. C. Pathberiya, 2016. "Optimal Monetary Policy at the Zero Lower Bound on Nominal Interest Rates in a Cost Channel Economy," Discussion Papers Series 568, School of Economics, University of Queensland, Australia.

    More about this item

    Keywords

    New-Keynesian Model; Inflation Target; Liquidity Trap;

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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