Monetary policy trade-offs at the zero lower bound

Stefano Eusepi, Christopher Gibbs and Bruce Preston

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: We study zero interest-rate policy in response to a large negative demand shock when long-run inflation expectations can fall over time. Because falling expectations make monetary policy less effective by raising real interest rates, the optimal forward guidance policy makes large front-loaded promises to stabilize expectations. Policy is too stimulatory in the event of transitory shocks, but provides insurance against persistent shocks. Optimal policy is well-approximated by a constant calendar-based forward guidance, independent of the shock’s realized persistence. This insurance principle qualitatively and quantitatively distinguishes our paper from other recent research on bounded rationality and the forward guidance puzzle.

Keywords: Optimal Monetary Policy; Learning Dynamics; Expectations Stabilization; Forward Guidance (search for similar items in EconPapers)
JEL-codes: D83 D84 E32 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2022-03
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-ias, nep-mac and nep-mon
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2022-26

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