Optimal monetary policy at the zero-interest-rate bound

Taehun Jung, Yuki Teranishi, Tsutomu Watanabe

Research output: Contribution to journalReview article

103 Citations (Scopus)

Abstract

What should a central bank do when faced with a weak aggregate demand even after reducing the short-term nominal interest rate to zero? To address this question, we solve a central bank's intertemporal loss-minimization problem, in which the non-negativity constraint on nominal interest rates is explicitly considered. We find that the optimal path is characterized by policy inertia, in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level. By making such a commitment, the central bank is able to achieve higher expected inflation, lower long-term nominal interest rates, and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady-state level.

Original languageEnglish
Pages (from-to)813-835
Number of pages23
JournalJournal of Money, Credit and Banking
Volume37
Issue number5
DOIs
Publication statusPublished - 2005 Oct 1
Externally publishedYes

Keywords

  • Liquidity trap
  • Monetary policy inertia
  • The zero bound on nominal interest rates
  • Zero interest rate policy

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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