Working Paper: CEPR ID: DP3892
Authors: Günter Coenen; Athanasios Orphanides; Volker Wieland
Abstract: This Paper employs stochastic simulations of a small structural rational expectations model to investigate the consequences of the zero bound on nominal interest rates. We find that if the economy is subject to stochastic shocks similar in magnitude to those experienced in the US over the 1980s and 1990s, the consequences of the zero bound are negligible for target inflation rates as low as 2%. The effects of the constraint are, however, non-linear with respect to the inflation target and produce a quantitatively significant deterioration of the performance of the economy with targets between 0 and 1%. The variability of output increases significantly and that of inflation also rises somewhat. Also, we show that the asymmetry of the policy ineffectiveness induced by the zero bound generates a non-vertical long-run Phillips curve. Output falls increasingly short of potential with lower inflation targets.
Keywords: inflation targeting; liquidity trap; monetary policy rules; price stability
JEL Codes: E31; E52; E58; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation target (E31) | economic performance (P17) |
| lower inflation targets (E31) | increased variability of output and inflation (E39) |
| lower inflation targets (E31) | more frequent and prolonged recessions (E32) |
| zero bound constraint (D10) | modifies expected behavior of nominal interest rates (E43) |
| inflation target (E31) | output performance (C67) |
| zero average inflation (E31) | output losses (D57) |