Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates

Klaus Adam () and Roberto M. Billi ()

No 2004/13, CFS Working Paper Series from Center for Financial Studies

Abstract: We determine optimal monetary policy under commitment in a forwardlooking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not require targeting a positive average rate of inflation. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) mark-up shocks.

Keywords: nonlinear optimal policy; zero interest rate bound; commitment; liquidity trap; New Keynesian (search for similar items in EconPapers)
JEL-codes: C63 E31 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2004-01-13
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Related works:
Journal Article: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2006)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2005)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2004)
Working Paper: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2004)
Working Paper: Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates (2003)
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