Price Stability and Monetary Policy Effectiveness When Nominal Interest Rates are Bounded at Zero

29 Pages Posted: 24 Jun 2003

See all articles by Günter Coenen

Günter Coenen

European Central Bank (ECB)

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Volker Wieland

University of Frankfurt

Multiple version iconThere are 2 versions of this paper

Date Written: May 2003

Abstract

This Paper employs stochastic simulations of a small structural rational expectations model to investigate the consequences of the zero bound on nominal interest rates. We find that if the economy is subject to stochastic shocks similar in magnitude to those experienced in the US over the 1980s and 1990s, the consequences of the zero bound are negligible for target inflation rates as low as 2%. The effects of the constraint are, however, non-linear with respect to the inflation target and produce a quantitatively significant deterioration of the performance of the economy with targets between 0 and 1%. The variability of output increases significantly and that of inflation also rises somewhat. Also, we show that the asymmetry of the policy ineffectiveness induced by the zero bound generates a non-vertical long-run Phillips curve. Output falls increasingly short of potential with lower inflation targets.

Keywords: Inflation targeting, price stability, monetary policy rules, liquidity trap

JEL Classification: E31, E52, E58, E61

Suggested Citation

Coenen, Günter and Orphanides, Athanasios and Wieland, Volker, Price Stability and Monetary Policy Effectiveness When Nominal Interest Rates are Bounded at Zero (May 2003). Available at SSRN: https://ssrn.com/abstract=419467

Günter Coenen (Contact Author)

European Central Bank (ECB) ( email )

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Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Asia School of Business ( email )

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Malaysia

Volker Wieland

University of Frankfurt ( email )

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Germany
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HOME PAGE: http://www.volkerwieland.com