Working Paper: NBER ID: w31508
Authors: Roberto M. Billi; Jordi Gal; Anton Nakov
Abstract: We study the optimal monetary policy problem in a New Keynesian economy with a zero lower bound (ZLB) on the nominal interest rate, when the steady state natural rate (r*) becomes permanently negative. We show that the optimal policy aims to approach gradually a new steady state with positive average inflation. Around that steady state, the optimal policy implies well defined (second-best) paths for inflation and output in response to shocks to the natural rate. Under plausible calibrations, the optimal policy implies that the nominal rate remains at its ZLB most of the time. Despite the latter feature, the central bank can implement the optimal outcome as a unique equilibrium by means of an appropriate nonlinear interest rate rule. In order to establish that result, we derive sufficient conditions for local determinacy in a general model with endogenous regime switches.
Keywords: No keywords provided
JEL Codes: E32; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative natural rate of interest (r) (E43) | positive inflation (E31) |
| negative natural rate of interest (r) (E43) | binding zero lower bound (ZLB) (E43) |
| binding zero lower bound (ZLB) (E43) | suboptimal economic conditions (E66) |
| low volatility of natural rate (r) (E43) | binding zero lower bound (ZLB) (E43) |
| fluctuations in natural rate (r < 0) (E32) | nominal rate and inflation (E31) |