Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates

Klaus Adam and Roberto Billi

No 4111, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We compute the optimal non-linear interest rate policy under commitment for a forward-looking stochastic model with monopolistic competition and sticky prices when nominal interest rates are bounded below by zero. When the lower bound binds, the optimal policy is to reduce the real rate by generating inflation expectations. This is achieved by committing to increase future interest rates by less than what purely forward-looking policy would suggest. As a result, there is a ?commitment bias?, i.e., average output and inflation turn out to be higher than their target values. Calibrating the model to the US economy we find that the quantitative importance of the average effects on output and inflation are negligible. Moreover, the empirical magnitude of US mark-up shocks is too small to entail zero nominal interest rates. Real rate shocks, however, plausibly lead to a binding lower bound under optimal policy, albeit relatively infrequently. Interestingly, the presence of binding real rate shocks alters the optimal policy response to (non-binding) mark-up shocks.

Keywords: C63; Non-linear optimal policy; Zero interest rate bound; Commitment; Liquidity trap; New keynesian (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
Date: 2003-11
New Economics Papers: this item is included in nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

Downloads: (external link)
https://cepr.org/publications/DP4111 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2006)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2005)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2004)
Working Paper: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2004)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2004)
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:cpr:ceprdp:4111

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP4111

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().