Optimal monetary policy under discretion with a zero bound on nominal interest rates
Klaus Adam () and
No 380, Working Paper Series from European Central Bank
We determine optimal discretionary monetary policy in a New-Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such 'preemptive easing' is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the U.S. economy we ﬁnd the easing effect to be quantitatively important. Moreover, signiﬁcant welfare losses. Losses increase further when inﬂation is partly determined by lagged inﬂation in the Phillips curve. Targeting positive inﬂation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear signiﬁcant and are much larger than in the case without lower bound. JEL Classification: C63, E31, E52
Keywords: liquidity trap; nonlinear policy; zero lower bound (search for similar items in EconPapers)
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Working Paper: Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2004380
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