Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates

Klaus Adam () and Roberto M. Billi ()

No 4585, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We determine optimal discretionary monetary policy in a New Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such ‘pre-emptive easing’ is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the US economy we find the easing effect to be quantitatively important. Moreover, the lower bound binds rather frequently and imposes significant welfare losses. Losses increase further when inflation is partly determined by lagged inflation in the Phillips curve. Targeting positive inflation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear significant and are much larger than in the case without lower bound.

Keywords: C63; liquidity trap; nonlinear policy; zero lower bound (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-mon
Date: Written 2004-08
View citations in EconPapers

Downloads: (external link)
http://www.cepr.org/pubs/dps/DP4585.asp (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: Optimal monetary policy under discretion with a zero bound on nominal interest rates (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Ordering information: This working paper can be ordered from
http://www.cepr.org/pubs/dps/DP4585.asp

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers
Address: Centre for Economic Policy Research, 53--56 Great Sutton Street, London EC1V 0DG
Series data maintained by ().