Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates

46 Pages Posted: 9 Dec 2004

See all articles by Klaus Adam

Klaus Adam

University of Mannheim; European Central Bank (ECB) - Department of Research; Centre for Economic Policy Research (CEPR)

Roberto M. Billi

Sveriges Riksbank

Multiple version iconThere are 2 versions of this paper

Date Written: August 2004

Abstract

We determine optimal discretionary monetary policy in a New-Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such "preemptive easing" is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the U.S. economy we find the easing effect to be quantitatively important. Moreover, significant welfare losses. Losses increase further when inflation is partly determined by lagged inflation in the Phillips curve. Targeting positive inflation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear significant and are much larger than in the case without lower bound.

Keywords: nonlinear policy, zero lower bound, liquidit y trap

JEL Classification: C63, E31, E52

Suggested Citation

Adam, Klaus and Billi, Roberto M., Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates (August 2004). Available at SSRN: https://ssrn.com/abstract=564625 or http://dx.doi.org/10.2139/ssrn.564625

Klaus Adam (Contact Author)

University of Mannheim ( email )

Department of Economics
L7 ,3-5
Mannheim, 68131
Germany

HOME PAGE: http://adam.vwl.uni-mannheim.de/1528.0.html

European Central Bank (ECB) - Department of Research ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6597 (Phone)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Roberto M. Billi

Sveriges Riksbank ( email )

Brunkebergstorg 11
SE-103 37 Stockholm
Sweden

HOME PAGE: http://www.rmbilli.com