Exchange-Rate Policy and the Zero Bound on Nominal Interest

Posted: 27 Apr 2004

See all articles by Volker Wieland

Volker Wieland

University of Frankfurt

Günter Coenen

European Central Bank (ECB)

Date Written: August 2004

Abstract

In this paper, we study the effectiveness of monetary policy in a severe recession and deflation when nominal interest rates are bounded at zero. We compare two alternative proposals for ameliorating the effect of the zero bound: an exchange-rate peg and price-level targeting. We conduct this quantitative comparison in an empirical macroeconometric model of Japan, the United States and the euro area. Furthermore, we use a stylized micro-founded two-country model to check our qualitative findings. We find that both proposals succeed in generating inflationary expectations and work almost equally well under full credibility of monetary policy. However, price-level targeting may be less effective under imperfect credibility, because the announced price-level target path is not directly observable.

Keywords: Monetary policy rules, zero-interest-rate bound, liquidity trap, rational expectations, nominal rigidities, exchange rates

JEL Classification: E31, E52, E58, E61

Suggested Citation

Wieland, Volker and Coenen, Günter, Exchange-Rate Policy and the Zero Bound on Nominal Interest (August 2004). Available at SSRN: https://ssrn.com/abstract=535902

Volker Wieland (Contact Author)

University of Frankfurt ( email )

House of Finance
Grüneburgplatz 1
Frankfurt am Main, D-60323
Germany
+49 69 798 33805 (Phone)
+49 69 798 33907 (Fax)

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

Günter Coenen

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 7887 (Phone)
+49 69 1344 6575 (Fax)

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