Parameter Uncertainty and Effective Lower Bound Risk

Naoto Soma
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Naoto Soma: Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, Associate Professor, Yokohama National University, E-mail: soma-naoto-wb@ynu.ac.jp)

No 21-E-11, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: Uncertainty is a fact of life for central banks, and the effective lower bound (ELB) of short-term nominal interest rates has become one source of uncertainty for many of them. This paper analyzes the effects of uncertainty about monetary policy transmission on inflation in a canonical New Keynesian model with optimal discretionary monetary policy under the ELB. The main finding is that a greater degree of uncertainty enlarges the "deflationary bias" of the economy. In the model, the central bank reacts to the uncertainty by attenuating the response of the nominal interest rate to exogenous shocks. Such inactive policy response leaves the fall in inflation caused by the ELB risk partially untreated, which lowers the inflation expectations of private agents and results in undershooting of the inflation target.

Keywords: Model Uncertainty; Effective Lower Bound; Deflationary Bias; Risky Steady State (search for similar items in EconPapers)
JEL-codes: D81 E32 E52 (search for similar items in EconPapers)
Date: 2021-11
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:ime:imedps:21-e-11

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