Optimal monetary policy under commitment with a zero bound on nominal interest rates

Klaus Adam and Roberto Billi

No RWP 05-07, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: We determine optimal monetary policy under commitment in a forward-looking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not imply positive average inflation rates in equilibrium. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) mark-up shocks

Keywords: Monetary policy; Keynesian economics; Liquidity (Economics); Interest rates (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2006)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2004)
Working Paper: Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates (2004)
Working Paper: Optimal monetary policy under commitment with a zero bound on nominal interest rates (2004)
Working Paper: Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates (2003)
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