Optimal monetary policy at the zero-interest-rate bound

Taehun Jung, Yuuki Teranishi, Tsutomu Watanabe

Research output: Contribution to journalArticle

88 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
Externally publishedYes

Fingerprint

Central bank
Interest rates
Nominal interest rate
Optimal monetary policy
Natural rate of interest
Interest rate policy
Optimal path
Expected inflation
Aggregate demand
Inertia
Currency

Keywords

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

ASJC Scopus subject areas

  • Finance
  • Accounting
  • Economics and Econometrics

Cite this

Optimal monetary policy at the zero-interest-rate bound. / Jung, Taehun; Teranishi, Yuuki; Watanabe, Tsutomu.

In: Journal of Money, Credit and Banking, Vol. 37, No. 5, 10.2005, p. 813-835.

Research output: Contribution to journalArticle

Jung, Taehun ; Teranishi, Yuuki ; Watanabe, Tsutomu. / Optimal monetary policy at the zero-interest-rate bound. In: Journal of Money, Credit and Banking. 2005 ; Vol. 37, No. 5. pp. 813-835.
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