Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates

By Klaus Adam, Roberto Billi. Social Science Research Network, 2006

453 citations recorded by the source corpus.

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 imply positive average inflation rates in equilibrium. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) markup shocks.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/0a12ad6a523d8eb4067a0d2523c01e888a7bd62f

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Citations in the corpus

Using monetary policy to stabilize economic activity (2009, background): “See Adams and Billi (2007) and Nakov (2008).”
Uncertainty at the zero lower bound (2017, unknown): “For the persistence parameter, ρ, I choose 0.8 as a benchmark, which is the value considered in Adam and Billi (2006), Adam and Billi (2007), and Nakov (2008).”
Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound (2012, unknown): “As noted by Walsh (2009), this feature is characteristic of the optimal policy path obtained by Eggertsson and Woodford (2003), who focused on two-state Markov shocks, and by Adam and Billi (2004, 2006) and Nakov (2008), who focused on relatively transitory autoregressive (AR) shocks.”
Monetary Policy in a Low Interest Rate World (2017, background): “The New Keynesian literature explores similar issues in more stylized models (Wolman 1998; Eggertsson and Woodford 2003; Adam and Billi 2006)—with Gauti Eggertsson and Michael Woodford (2003) emphasizing how changes in the policy strategy, involving commitments akin to price level targeting, can…”
The Optimal Rate of Inflation (2010, unknown): “This conjecture is supported by the work of Adam and Billi (2006).”