Working Paper: NBER ID: w21838
Authors: Susanto Basu; Brent Bundick
Abstract: At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.
Keywords: Endogenous Volatility; Zero Lower Bound; Stabilization Policy
JEL Codes: E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in uncertainty about future shocks (D89) | significant contractions in economic activity (E32) |
| increase in uncertainty about future shocks (D89) | increase in precautionary savings behavior (D14) |
| increase in precautionary savings behavior (D14) | reduction in aggregate demand (E00) |
| reduction in aggregate demand (E00) | prolonged periods of economic stagnation (E32) |
| Taylor rule for monetary policy interacts with uncertainty (C54) | contractionary bias (E62) |
| higher expected real interest rates (E43) | reduce output and inflation (E31) |
| optimal monetary policy can mitigate endogenous volatility (E63) | stabilize household consumption expectations (D10) |