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Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound

Siddhartha Chattopadhyay and Taniya Ghosh ()
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Siddhartha Chattopadhyay: Indian Institute of Technology, Kharagpur

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: Cost channel introduces trade-off between inflation rate and output gap. Unlike the canonical New Keynesian DSGE model, optimal monetary policy cannot set both inflation rate and output gap simultaneously to zero under a demand shock. Using a perfect foresight New Keynesian model with cost channel, this paper analyzes the optimal discretionary monetary policy under Zero Lower Bound (ZLB) for varying degree of interest rate pass-through. We find (i) exit date from ZLB becomes endogenous due to the trade-off between output gap and inflation introduced by the cost channel; (ii) presence of cost channel delays the exit from ZLB compared to models without cost channel; and (iii) exit date rises monotonically with the magnitude of demand shock and degree of interest rate pass-through.

Keywords: New-Keynesian Model; Inflation Target; Liquidity Trap (search for similar items in EconPapers)
JEL-codes: E63 E52 E58 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2016-05
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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