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Asymmetric monetary policy and the effective lower bound

Christopher Gust, David López-Salido and Steve Meyer

Research in Economics, 2017, vol. 71, issue 3, 441-451

Abstract: We use the canonical New Keynesian model to study optimal discretionary policy when the nominal interest rate is constrained by the effective lower bound (ELB). We show that policymakers who seek to minimize a (symmetric) quadratic loss function involving deviations of inflation and output from targets will achieve an average inflation rate below target due to the contractionary effects associated with hitting the ELB. We also characterize optimal discretionary policy for policymakers who view output losses as asymmetric: they place weight on the output gap when output is below potential but place little or no weight on the gap when output is above potential. In comparison to optimal policy using the symmetric loss function, the average inflation rate is higher and closer to the central banks target. Moreover, in response to contractionary demand shocks that push the nominal interest rate to the effective lower bound, policymakers with an asymmetric loss function adopt a policy rate path that remains at the ELB longer but eventually rises more quickly than the path adopted by a policymaker with a symmetric loss function.

Keywords: Zero lower bound; Optimal monetary policy; Asymmetric loss function; Time-consistent policy (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:reecon:v:71:y:2017:i:3:p:441-451