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Risk Management for Monetary Policy at the Zero Lower Bound

Author

Listed:
  • Francois Gourio

    (FRB Chicago)

  • Jonas Fisher

    (Federal Reserve Bank of Chicago)

Abstract

As labor markets improve and projections have inflation heading back toward target, the Fed has begun to contemplate lifting the federal funds rate from its zero lower bound (ZLB). Under what conditions should the Fed start raising rates? We lay out an argument that calls for caution. It is founded on a risk management principle that says policy should be formulated taking into account the dispersion of outcomes around the mean forecast. On the one hand, raising rates early increases the likelihood of adverse shocks driving a fragile economy back to the ZLB. On the other hand, delaying lift-off when the economy turns out to be resilient could lead to an unwelcome bout of inflation. Since the tools available to counter the first scenario are hard to implement and may be less effective than the traditional tool of raising rates to counter the second scenario, the costs of premature lift-o exceed those of delay. This article shows in a canonical framework that uncertainty about being constrained by the ZLB in the future implies an optimal policy of delayed lift-o. We present evidence that such a risk management policy is consistent with past Fed actions and that unconventional tools will be hard to implement if the economy were to be constrained by the ZLB after a hasty exit.

Suggested Citation

  • Francois Gourio & Jonas Fisher, 2015. "Risk Management for Monetary Policy at the Zero Lower Bound," 2015 Meeting Papers 665, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:665
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    Cited by:

    1. Delano S. Villanueva, "undated". "Challenges for Inflation Targeting," Working Papers wp10, South East Asian Central Banks (SEACEN) Research and Training Centre.
    2. repec:eee:eecrev:v:100:y:2017:i:c:p:257-272 is not listed on IDEAS
    3. Caggiano, Giovanni & Castelnuovo, Efrem & Pellegrino, Giovanni, 2017. "Estimating the real effects of uncertainty shocks at the Zero Lower Bound," European Economic Review, Elsevier, vol. 100(C), pages 257-272.
    4. Kohei Hasui & Tomohiro Sugo & Yuki Teranishi, 2016. "Liquidity Trap and Optimal Monetary Policy Revisited," UTokyo Price Project Working Paper Series 061, University of Tokyo, Graduate School of Economics.
    5. Ali Alichi & Kevin Clinton & Charles Freedman & Ondra Kamenik & Michel Juillard & Douglas Laxton & Jarkko Turunen & Hou Wang, 2015. "Avoiding Dark Corners; A Robust Monetary Policy Framework for the United States," IMF Working Papers 15/134, International Monetary Fund.

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