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The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates

Roberto Billi

No 25, Computing in Economics and Finance 2005 from Society for Computational Economics

Abstract: This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy

Keywords: inflation inertia; downward nominal rigidity; nonlinear policy; liquidity trap (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: 2005-11-11
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http://repec.org/sce2005/up.27221.1104375907.pdf (application/pdf)

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