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Risk Management for Monetary Policy Near the Zero Lower Bound

Charles Evans (), Jonas Fisher (), Francois Gourio () and Spencer Krane

No WP-2015-3, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: As projections have inflation heading back toward target and the labor market continuing to improve, the Federal Reserve has begun to contemplate an increase in the federal funds rate. There is however substantial uncertainty around these projections. How should this uncertainty affect monetary policy? In many standard models uncertainty has no effect. In this paper, we demonstrate that the zero lower bound on nominal interest rates implies that the central bank should adopt a looser policy when there is uncertainty. In the current context this result implies that a delayed liftoff is optimal. We demonstrate this result theoretically in two canonical macroeconomic models. Using numerical simulations of our models, calibrated to the current environment, we find optimal policy calls for 2 to 3 quarters delay in liftoff relative to a policy that does not take into account uncertainty about policy being constrained by the ZLB. We then use a narrative study of Federal Reserve communications and estimated policy reaction functions to show that risk management is a longstanding practice in the conduct of monetary policy.

Keywords: risk; monetary policy; risk management; zero lower bound (search for similar items in EconPapers)
JEL-codes: E53 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2015-05-21
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