Monetary policy rules and the effective lower bound in the Euro area

Markus Haavio and Olli-Matti Laine

No 5/2021, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We analyze the economic performance of di§erent monetary policy strategies, or rules, in a low interest rate environment, using simulations with a DSGE model which has been estimated for the euro area. We study how often the e§ective lower bound of interest rates (ELB) is likely to bind, and how much forgone monetary policy accommodation this entails. Macroeconomic outcomes are measured by the mean levels and the volatility of output (gaps), unemployment and ináation. We present three sets of results. First, the macroeconomic costs of the ELB are likely to grow in a non-linear manner if the monetary policy space (the di§erence between the normal, or average, level of nominal interest rates and the ELB) shrinks. Second, a point ináation target appears to outperform a target range. Third, the (relative) performance of low-for-long (L4L) monetary policy rules depends on the size of the monetary policy space. The L4L rules tend to perform well, if the monetary space is small, but if the space is larger these rules, while stabilizing ináation, may lead to more volatility in the real economy than áexible ináation targeting.

Keywords: monetary policy rules; effective lower bound; euro area (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E58 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofrdp:rdp2021_005

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