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Uncertainty and the Zero Lower Bound: A Theoretical Analysis

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  • Mendes, Rhys R.

Abstract

This paper demonstrates how to analytically characterize the set of rational expectations equilibria in a simple stochastic New Keynesian model with the zero lower bound. In this environment, purely forward-looking (non-history-dependent) monetary policies are not generally consistent with existence of rational expectations equilibria. In particular, equilibria exist only when the volatility of the shocks is below some threshold level. This non-existence result is a consequence of the fact that the expected average policy rate rises with the level of uncertainty in the presence of the zero lower bound under forward-looking policies. History-dependent policies can be designed to eliminate the tendency of the expected average policy rate to rise with uncertainty, thereby potentially mitigating the non-existence problems. The non-existence results are likely quite robust, as the only structural feature of the economy upon which they depend is the Fisher condition.

Suggested Citation

  • Mendes, Rhys R., 2011. "Uncertainty and the Zero Lower Bound: A Theoretical Analysis," MPRA Paper 59218, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:59218
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Susanto Basu & Brent Bundick, 2017. "Uncertainty Shocks in a Model of Effective Demand," Econometrica, Econometric Society, vol. 85, pages 937-958, May.
    2. Martin Seneca, 2020. "Risk Shocks and Monetary Policy in the New Normal," International Journal of Central Banking, International Journal of Central Banking, vol. 16(6), pages 185-232, December.
    3. S. Bogan Aruoba & Pablo Cuba-Borda & Kenji Higa-Flores & Frank Schorfheide & Sergio Villalvazo, . "Piecewise-Linear Approximations and Filtering for DSGE Models with Occasionally Binding Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    4. Seneca, Martin, 2016. "Risk shocks close to the zero lower bound," Bank of England working papers 606, Bank of England.
    5. Nakata, Taisuke & Schmidt, Sebastian, 2019. "Conservatism and liquidity traps," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 37-47.
    6. Thomas M. Mertens & John C. Williams, 2019. "Tying down the anchor: monetary policy rules and the lower bound on interest rates," Staff Reports 887, Federal Reserve Bank of New York.
    7. Holden, Thomas, 2016. "Existence and uniqueness of solutions to dynamic models with occasionally binding constraints," EconStor Preprints 130142, ZBW - Leibniz Information Centre for Economics.
    8. Taisuke Nakata, 2017. "Uncertainty at the Zero Lower Bound," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(3), pages 186-221, July.
    9. Nakata, Taisuke, 2016. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 220-240.
    10. Roulleau-Pasdeloup, Jordan, 2020. "Optimal monetary policy and determinacy under active/passive regimes," European Economic Review, Elsevier, vol. 130(C).
    11. S. Bogan Aruoba & Pablo Cuba-Borda & Kenji Higa-Flores & Frank Schorfheide & Sergio Villalvazo, . "Piecewise-Linear Approximations and Filtering for DSGE Models with Occasionally Binding Constraints," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    12. Michael Plante & Alexander W. Richter & Nathaniel A. Throckmorton, 2018. "The Zero Lower Bound and Endogenous Uncertainty," Economic Journal, Royal Economic Society, vol. 128(611), pages 1730-1757, June.
    13. Morris, Stephen D., 2020. "Is the Taylor principle still valid when rates are low?," Journal of Macroeconomics, Elsevier, vol. 64(C).
    14. Thomas M. Mertens & John C. Williams, 2018. "What to expect from the lower bound on interest rates: evidence from derivatives prices," Staff Reports 865, Federal Reserve Bank of New York.
    15. Benjamin K. Johannsen, 2014. "When are the Effects of Fiscal Policy Uncertainty Large?," Finance and Economics Discussion Series 2014-40, Board of Governors of the Federal Reserve System (U.S.).

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    More about this item

    Keywords

    Monetary Policy; Zero Lower Bound; New Keynesian Models;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • 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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