The Risky Steady State and the Interest Rate Lower Bound

Taisuke Nakata, Sebastian Schmidt and Timothy Hills
Additional contact information
Sebastian Schmidt: European Central Bank
Timothy Hills: New York University

No 39, 2016 Meeting Papers from Society for Economic Dynamics

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 45 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 recent ELB experience has led households and firms to revise up their estimate of the ELB frequency.

Date: 2016
New Economics Papers: this item is included in nep-dge and nep-mon
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Related works:
Working Paper: The risky steady state and the interest rate lower bound (2016)
Working Paper: The Risky Steady State and the Interest Rate Lower Bound (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:39

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