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Real Implications of the Zero Bound on Nominal Interest Rates

  • Alexander L. Wolman


    (Federal Reserve Bank of Richmond)

When price-setting is staggered and firms choose prices optimally, low inflation regimes (where the nominal interest rate is occasionally zero) do not entail significant distortions to the real economy. By targeting the price level, the monetary authority can generate temporarily expected inflation when nominal rates are zero, pushing real rates down. In contrast, when firms choose their prices according to the Fuhrer-Moore rule, the zero bound causes real distortions. By targeting the price level instead of inflation, however, the monetary authority can lessen those distortions.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 1999 with number 1152.

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Date of creation: 01 Mar 1999
Date of revision:
Handle: RePEc:sce:scecf9:1152
Contact details of provider: Postal: CEF99, Boston College, Department of Economics, Chestnut Hill MA 02467 USA
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  1. Jeff Fuhrer & Brian Madigan, 1994. "Monetary policy when interest rates are bounded at zero," Working Papers in Applied Economic Theory 94-06, Federal Reserve Bank of San Francisco.
  2. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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  9. Willem H. Buiter & Nikolaos Panigirtzoglou, 1999. "Liquidity Traps: How to Avoid Them and How to Escape Them," NBER Working Papers 7245, National Bureau of Economic Research, Inc.
  10. Goodfriend, Marvin, 2000. "Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1007-35, November.
  11. McGrattan, Ellen R., 1996. "Solving the stochastic growth model with a finite element method," Journal of Economic Dynamics and Control, Elsevier, vol. 20(1-3), pages 19-42.
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  13. Michael Dotsey, 1999. "Structure from shocks," Working Paper 99-06, Federal Reserve Bank of Richmond.
  14. Bennett T. McCallum, 2000. "Theoretical analysis regarding a zero lower bound on nominal interest rates," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 870-935.
  15. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
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  19. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc.
  20. Alexander L. Wolman, 1997. "Zero inflation and the Friedman rule: a welfare comparison," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-21.
  21. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
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  26. repec:nbr:nberre:0126 is not listed on IDEAS
  27. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
  28. Alexander L. Wolman, 1998. "Staggered price setting and the zero bound on nominal interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-24.
  29. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  30. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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