Monetary policy strategies for the euro area: optimal rules in the presence of the ELB

Falk Mazelis, Roberto Motto and Annukka Ristiniemi

No 2797, Working Paper Series from European Central Bank

Abstract: We study alternative monetary policy strategies in the presence of the lower bound on nominal interest rates and a low equilibrium real rate using an estimated DSGE model for the euro area. We find that simple feedback rules that implement inflation targeting result in a binding lower bound one-fourth of the time as well as inflation and output exhibiting large downward biases and heightened volatility. Rule-based asset purchases that are activated once the policy rate reaches the lower bound are not able to fully offset the destabilizing effects of the lower bound if we assume plausible limits on the size of purchases. Makeup strategies, especially average inflation targeting with a long averaging window, perform better than inflation targeting. However, differences in performance across strategies become small if the response coefficients of the feedback rules are optimized. In addition, we find that the benefits of makeup strategies tend to vanish if agents exhibit a degree of inattention to central bank policies as estimated in the data. JEL Classification: E31, E32, E37, E52, E58, E61, E71

Keywords: asset purchases; effective lower bound; forward guidance; makeup strategies; monetary policy; optimal policy (search for similar items in EconPapers)
Date: 2023-03
New Economics Papers: this item is included in nep-ban, nep-cba, nep-des, nep-dge, nep-eec, nep-mac and nep-mon
Note: 2591813
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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