Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/241250 
Year of Publication: 
2021
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2021-27
Publisher: 
Bank of Canada, Ottawa
Abstract: 
Over the last few decades, real interest rates have trended downward in many countries. The most common explanation is that this reflects depressed demand due to demographic, technological and other real factors such as income inequality. In this paper we explore the claim that these trends may have been amplified by certain features of monetary policy. We show that when long-run asset demands by households are C-shaped in relation to real interest rates, a feature we motivate through bequest motives, monetary policy has the potential to affect steady-state properties even if money is neutral in the long run. In particular, we show that if monetary policy reacts aggressively to inflation, this supports a steady state where inflation is close to the central bank's target. However, the same aggressive policy simultaneously favours the emergence of, and the convergence to, a second stable and determinate steady state where both the real interest rate and inflation are lower and monetary policy is constrained by the effective lower bound. We discuss how fiscal policy can be used to escape this low-real-rate, low-inflation trap with the potential for a discontinuous response of long-run inflation.
Subjects: 
Monetary policy
Fiscal policy
Economic models
Inflation and prices
Interest rates
Debt management
JEL: 
E2
E43
E44
E5
E52
E62
E63
H3
H6
H63
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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