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Asymmetric monetary policy responses and the effects of a rise in the inflation target

Benjamin Garcia ()

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: The effective lower bound (ELB) on interest rates introduces an explicit non-linearity for feasible monetary policy paths: interest rates cannot go below a certain rate. In a forward looking environment, the ELB can affect the monetary policy decisions not only when the bound is reached, but also when there is a possibility that the bound may be reached in the future. In this context, as a recommendation for monetary policy in a low-inflation environment, Reifschneider and Williams (2002 FOMC) propose an asymmetric Taylor Rule with a threshold level that automatically drives the interest rate to zero whenever they fall below one percent. I test the hypothesis that the Federal Reserve has behaved in a manner consistent with Reifschneider and Williams’ advice, finding evidence of a negative correlation between the level of the interest rate and the strength of the monetary policy response. Using an estimated nonlinear DSGE model, I show that a monetary policy which act symmetrically and asymmetrically can have significantly different consequences. In particular, I study the relevance of this behavior for the analysis of a permanent rise of the inflation target.

New Economics Papers: this item is included in nep-cba, nep-dge, nep-knm, nep-mac and nep-mon
Date: 2018-06
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