Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/154409
Authors: 
Nakata, Taisuke
Schmidt, Sebastian
Year of Publication: 
2016
Series/Report no.: 
ECB Working Paper 1976
Abstract: 
Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy where large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function does. Through expectations, the temporary overheating of the economy associated with such low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than half.
Subjects: 
gradualism
inflation targeting
interest-rate smoothing
liquidity traps
zero lower bound
JEL: 
E52
E61
Document Type: 
Working Paper

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