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Exchange Rate Policy and the Zero Bound on Nominal Interest Rates

  • Volker Wieland (Goethe University Frankfurt)
  • Günter Coenen (European Central Bank)

In this paper, we study the effectiveness of monetary policy in a severe recession and deflation when nominal interest rates are bounded at zero. We compare two alternative proposals for ameliorating the effect of the zero bound: an exchange-rate peg and price-level targeting. We conduct this quantitative comparison in an empirical macroeconometric model of Japan, the United States and the euro area. Furthermore, we use a stylised micro-founded two-country model to check our quantitative findings. We find that both proposals succeed in generating inflationary expectations and work almost equally well under full credibility of monetary policy. However, price-level targeting may be less effective under imperfect credibility, because the announced price-level target is not directly observable.

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File URL: http://repec.org/sce2004/up.18339.1076941732.pdf
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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 65.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:65
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