The Zero Bound on Nominal Interest Rates: Implications for the Optimal Monetary Policy in Canada

Claude Lavoie and Hope Pioro

Discussion Papers from Bank of Canada

Abstract: The authors assess the performance of the Canadian economy under a variety of interest rate rules when the zero bound on nominal interest rates can bind. Their assessment is based on numerical simulations of a dynamic stochastic general-equilibrium model in a stochastic environment. Consistent with the literature, the authors find that the probability and consequences of the zero bound depend strongly on the targeted rate of inflation and that price-level targeting generally leads to better outcomes. Their results show that a non-linear rule is preferable to a linear rule under both inflation and price-level targeting, because of the zero-bound issue. This suggests that central banks should be pre-emptive and adopt an aggressive monetary policy when expected inflation falls below its desired level. The authors' results also show that the monetary authority must be much more forward looking under price-level targeting than under inflation targeting.

Keywords: Inflation: costs and benefits; Interest rates; Monetary policy framework (search for similar items in EconPapers)
JEL-codes: E43 E47 E52 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2007
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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