Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/278364 
Year of Publication: 
2023
Series/Report no.: 
ECB Working Paper No. 2788
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
Empirical analyses starting from Laubach and Williams (2003) find that the natural rate of interest is not constant in the long-run. This paper studies the optimal response to stochastic changes of the long-run natural rate in a suitably modified version of the new Keynesian model. We show that, because of the zero lower bound (ZLB) on nominal interest rates, movements towards zero of the long-run natural rate cause an increasingly large downward bias in expectations. To offset this bias, the central bank should aim to keep the real interest rate systematically below the long-run natural rate, as long as policy is not constrained by the ZLB. The neutral rate - the level of the policy rate consistent with stable inflation and the natural rate at its long-run level - will be lower than the long-run natural rate. This is the case both under optimal policy, and under a price level targeting rule. In the latter case, the neutral rate is equal to zero as soon as the long-run natural rate falls below 1%.
Subjects: 
nonlinear optimal policy
zero lower bound
commitment
liquidity trap
New Keynesian
JEL: 
C63
E31
E52
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-5984-1
Document Type: 
Working Paper

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