Effective Lower Bound Risk

Timothy S. Hills, Taisuke Nakata and Sebastian Schmidt

No 2019-077, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Even when the policy rate is currently not constrained by its effective lower bound (ELB), the possibility that the policy rate will become constrained in the future lowers today's inflation by creating tail risk in future inflation and thus reducing expected inflation. In an empirically rich model calibrated to match key features of the U.S. economy, we find that the tail risk induced by the ELB causes inflation to undershoot the target rate of 2 percent by as much as 50 basis points at the economy's risky steady state. Our model suggests that achieving the inflation target may be more difficult now than before the Great Recession, if the likely decline in long-run neutral rates has led households and firms to revise up their estimate of the frequency of future ELB events.

Keywords: Deflationary Bias; Disinflation; Effective Lower Bound; Inflation Targeting; Risky Steady State; Tail Risk (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 62 pages
Date: 2019-11-04
New Economics Papers: this item is included in nep-mac, nep-mon and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (25)

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Journal Article: Effective lower bound risk (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2019-77

DOI: 10.17016/FEDS.2019.077

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