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The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates

  • Roberto M. Billi


    (- Center for Financial Studies)

This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 25.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:25
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