Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/25437
Authors: 
Adam, Klaus
Billi, Roberto M.
Year of Publication: 
2004
Series/Report no.: 
CFS Working Paper 2004/13
Abstract: 
We determine optimal monetary policy under commitment in a forwardlooking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not require targeting a positive average rate of inflation. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) mark-up shocks.
Subjects: 
nonlinear optimal policy
zero interest rate bound
commitment
liquidity trap
New Keynesian
JEL: 
C63
E31
E52
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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