Gradualism and Liquidity Traps

Taisuke Nakata and Sebastian Schmidt

No 2016-092, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy in which large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function. Through expectations, the temporary overheating of the economy associated with such a low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than one-half.

Keywords: Gradualism; Inflation Targeting; Interest-Rate Smoothing; Liquidity Traps; Zero Lower Bound (search for similar items in EconPapers)
JEL-codes: E52 E61 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2016-11
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Downloads: (external link)
http://www.federalreserve.gov/econresdata/feds/2016/files/2016092pap.pdf (application/pdf)

Related works:
Journal Article: Gradualism and Liquidity Traps (2019)
Working Paper: Gradualism and liquidity traps (2016)
Working Paper: Gradualism and Liquidity Traps (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2016-92

DOI: 10.17016/FEDS.2016.092

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().