Working Paper: NBER ID: w9968
Authors: Gauti B. Eggertsson; Michael Woodford
Abstract: We consider the consequences for monetary policy of the zero floor for nominal interest rates. The zero bound can be a significant constraint on the ability of a central bank to combat deflation. We show, in the context of an intertemporal equilibrium model, that open-market operations, even of unconventional' types, are ineffective if they do not change expectations about the future conduct of policy; in this sense, a liquidity trap' is possible. Nonetheless, a credible commitment to the right sort of history-dependent policy can largely mitigate the distortions created by the zero bound. In our model, optimal policy involves a commitment to adjust interest rates so as to achieve a time-varying price-level target, when this is consistent with the zero bound. We also discuss ways in which other central-bank actions, while irrelevant apart from their effects on expectations, may help to make credible a central bank's commitment to its target, and consider implications for the policy options currently available for overcoming deflation in Japan.
Keywords: monetary policy; liquidity trap; quantitative easing; deflation
JEL Codes: E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| zero lower bound on nominal interest rates (E43) | central bank's ability to combat deflation (E58) |
| zero lower bound on nominal interest rates (E43) | welfare outcomes (I38) |
| credibility of commitment to history-dependent policy (E61) | distortions created by zero lower bound (E43) |
| open-market operations (E52) | expectations about future policy (D84) |
| expectations about future policy (D84) | current economic outcomes (E66) |