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

Arbeitspapier

We determine optimal monetary policy under commitment in a forwardlooking 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 require targeting a positive average rate of inflation.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 377

Classification and Topics

• Classification: Wirtschaft ; Computational Techniques; Simulation Modeling ; Price Level; Inflation; Deflation ; Monetary Policy
• Subject: commitment ; liquidity trap ; New Keynesian ; Nonlinear optimal policy ; zero interest rate bound

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Adam, Klaus ; Billi, Roberto M.
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2004

Further information

• Handle: http://hdl.handle.net/10419/152811
• Last update: 10.03.2025, 11:41 AM CET