Gradualism and liquidity traps

Sebastian Schmidt and Taisuke Nakata

No 1976, Working Paper Series from European Central Bank

Abstract: Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy where large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function does. Through expectations, the temporary overheating of the economy associated with such low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than half. JEL Classification: E52, E61

Keywords: gradualism; inflation targeting; interest-rate smoothing; Liquidity Traps; zero lower bound (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: 2179645
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Gradualism and Liquidity Traps (2019)
Working Paper: Gradualism and Liquidity Traps (2016)
Working Paper: Gradualism and Liquidity Traps (2016)
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