Resource title

Discretionary monetary policy and the zero lower bound on nominal interest rates

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Resource description

Ignoring the existence of the zero lower bound on nominal interest rates one considerably understates the value of monetary commitment in New Keynesian models. A stochastic forward-looking model with lower bound, calibrated to the U.S. economy, suggests that low values for the natural rate of interest lead to sizeable output losses and deflation under discretionary monetary policy. The fall in output and deflation are much larger than in the case with policy commitment and do not show up at all if the model abstracts from the existence of the lower bound. The welfare losses of discretionary policy increase even further when inflation is partly determined by lagged inflation in the Phillips curve. These results emerge because private sector expectations and the discretionary policy response to these expectations reinforce each other and cause the lower bound to be reached much earlier than under commitment.

Resource author

Klaus Adam, Roberto M. Billi

Resource publisher

Resource publish date

Resource language

eng

Resource content type

text/html

Resource resource URL

http://hdl.handle.net/10419/25419

Resource license

Adapt according to the presented license agreement and reference the original author.