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Optimal rules for central bank interest rates subject to zero lower bound

  • Singh, Ajay Pratap
  • Nikolaou, Michael

The celebrated Taylor rule provides a simple formula that aims to capture how the central bank interest rate is adjusted as a linear function of inflation and output gap. However, the rule does not take explicitly into account the zero lower bound on the interest rate. Prior studies on interest rate selection subject to the zero lower bound have not produced rigorous derivations of explicit rules. In this work, Taylor-like rules for central bank interest rates bounded below by zero are derived rigorously using a multi-parametric model predictive control (mpMPC) framework. Rules with or without inertia are included in the derivation. The proposed approach is illustrated through simulations on US economy data. A number of issues for future study are proposed.

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Paper provided by Kiel Institute for the World Economy (IfW) in its series Economics Discussion Papers with number 2013-49.

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Date of creation: 2013
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Handle: RePEc:zbw:ifwedp:201349
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