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The optimal inflation buffer with a zero bound on nominal interest rates

Roberto Billi

No 2005/17, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfaretheoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economy.

Keywords: Inflation Inertia; Downward Nominal Rigidity; Nonlinear Policy; Liquidity Trap (search for similar items in EconPapers)
JEL-codes: C63 E31 E52 (search for similar items in EconPapers)
Date: 2004
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