Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates

Thomas Mertens and John Williams

No 2019-14, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: This paper uses a standard New Keynesian model to analyze the effects and implementation of various monetary policy frameworks in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can eliminate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework that aims for above-target inflation during periods when policy is unconstrained. Second, dynamic strategies that raise inflation expectations by keeping interest rates “lower for longer” after periods of low inflation can both anchor expectations at the target level and further reduce the effects of the lower bound on the economy.

JEL-codes: E52 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2019-08-14
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Note: The original version of this Working Paper was published May 1, 2019.
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Citations: View citations in EconPapers (35)

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Working Paper: Tying down the anchor: monetary policy rules and the lower bound on interest rates (2019)
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DOI: 10.24148/wp2019-14

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