Optimal Monetary Policy at the Zero-Interest-Rate Bound

Taehun Jung, Yuki Teranishi and Tsutomu Watanabe

Journal of Money, Credit and Banking, 2005, vol. 37, issue 5, 813-35

Abstract: What should a central bank do when faced with a weak aggregate demand even after reducing the short-term nominal interest rate to zero? To address this question, we solve a central bank's intertemporal loss-minimization problem, in which the non-negativity constraint on nominal interest rates is explicitly considered. We find that the optimal path is characterized by policy inertia, in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level. By making such a commitment, the central bank is able to achieve higher expected inflation, lower long-term nominal interest rates, and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady-state level.

Date: 2005
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Citations: View citations in EconPapers (305)

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Persistent link: https://EconPapers.repec.org/RePEc:mcb:jmoncb:v:37:y:2005:i:5:p:813-35

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