Optimal Discretionary Monetary Policy in A Potential Zero Lower Bound Framework

Séverine Menguy
Additional contact information
Séverine Menguy: Université Paris Descartes, Sorbonne Paris Cité, 12 rue de l?école de médecine, 75270 PARIS CEDEX 06, France

International Journal of Economics and Financial Research, 2016, vol. 2, issue 6, 104-126

Abstract: In a recessionary and deflationary framework, the discretionary monetary policy cannot be optimal when the interest rate is already near zero and cannot decrease anymore. Indeed, when the Zero Lower Bound is binding, a negative demand shock implies a decrease in the current economic activity level and deflationary tensions, which cannot be avoided by monetary policy as the nominal interest rate can no longer decrease. The economic literature has then often recommended to target an inflation rate sufficiently above zero in order to avoid the dangers of this Zero Lower Bound (ZLB) constraint. On the contrary, provided the ZLB is not binding, monetary policy can efficiently contribute to the stabilization of economic activity and inflation in case of demand shocks. The variation in interest rates is then all the more accentuated as interest rate smoothing is a more negligible goal for the central bank. The contribution of our paper is to provide a clear analytical New-Keynesian framework sustaining these results. Besides, our analytical modelling also shows that even if the ZLB is currently not binding, the central bank should take into account the dangers of a potential future binding ZLB. Indeed, the interest rate should be decreased the fastest as a negative demand shock and the possibility to reach the ZLB is anticipated for a nearest future period. Our paper demonstrates the necessity of such a ‘pre-emptive’ active monetary policy even in a discretionary framework, which has the advantage to be time-consistent and to be in conformity with the empirical practices of independent central banks. We don’t have to make the strong hypothesis of a commitment monetary policy intended to affect private agents’ expectations in order to demonstrate the optimality of such a pre-emptive monetary policy.

Keywords: Monetary policy discretionary policy; New-Keynesian models; Zero lower Bound; Demand shocks. (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 E63 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.arpgweb.com/pdf-files/ijefr2(6)104-126.pdf (application/pdf)
http://www.arpgweb.com/?ic=journal&journal=5&month=06-2016&issue=6&volume=2 (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arp:ijefrr:2016:p:104-126

Access Statistics for this article

International Journal of Economics and Financial Research is currently edited by Dr. Abu Hassan Bin Md Isa

More articles in International Journal of Economics and Financial Research from Academic Research Publishing Group Rahim Yar Khan 64200, Punjab, Pakistan.
Bibliographic data for series maintained by Managing Editor ().