Working Paper: NBER ID: w27669
Authors: Gauti B. Eggertsson; Marc Giannoni
Abstract: Conventional wisdom suggests that medium-term money neutrality imposes strong limitations on the effects of monetary policy. The point of this paper is that models with medium- and long-term money neutrality are prone to generate non-existence of equilibria at the effective lower bound (ELB) on interest rates. Non-existence is suggestive of sharp output contractions --- so-called contractionary black holes --- at the ELB. Paradoxically, the case for expansionary monetary policy at the ELB is even stronger in models that feature near money neutrality. The results highlight the benefits of a monetary policy regime in which the central bank temporarily overshoots its inflation target once confronted by the ELB.
Keywords: money neutrality; effective lower bound; monetary policy; inflation; output
JEL Codes: E0; E13; E40; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Adverse shocks (E32) | decrease in short-run inflation (E31) |
| Adverse shocks (E32) | decrease in medium-run inflation expectations (E31) |
| decrease in short-run inflation (E31) | increase in real interest rate (E43) |
| decrease in medium-run inflation expectations (E31) | increase in real interest rate (E43) |
| increase in real interest rate (E43) | exacerbation of output contractions (E23) |
| medium or long-term money neutrality assumption (E49) | conflict with aggregate demand at ELB (E19) |
| degree of monetary neutrality (E49) | likelihood of output contractions at ELB (J89) |
| inflation expectations becoming ingrained (D84) | stimulative effects of monetary policy become larger (E52) |
| temporary overshooting of inflation target (E31) | stabilization of output and inflation (E63) |