Abstract

http://ssrn.com/abstract=1649000
 
 

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Imperfect Credibility and the Zero Lower Bound on the Nominal Interest Rate


Martin Bodenstein


Board of Governors of the Federal Reserve System

James Hebden


affiliation not provided to SSRN

Ricardo Cavaco Nunes


Federal Reserve Board

June 1, 2010


Abstract:     
When the nominal interest rate reaches its zero lower bound, credibility is crucial for conducting forward guidance. We determine optimal policy in a New Keynesian model when the central bank has imperfect credibility and cannot set the nominal interest rate below zero. In our model, an announcement of a low interest rate for an extended period does not necessarily reflect high credibility. Even if the central bank does not face a temptation to act discretionarily in the current period, policy commitments should not be postponed. In reality, central banks are often reluctant to allow a recovery path with output and inflation temporarily above target. From the perspective of our model such a policy reflects a low degree of credibility. We find increased forecast uncertainty in inflation and the output gap at the zero lower bound while interest rate uncertainty is reduced. Furthermore, misalignments between announced interest rate paths and market expectations are found to be best explained by lack of credibility.

Keywords: Monetary policy, zero interest rate bound, commitment, liquidity trap

JEL Classification: C61, E31, E52

working papers series


Not Available For Download

Date posted: July 26, 2010  

Suggested Citation

Bodenstein, Martin and Hebden, James and Nunes, Ricardo Cavaco, Imperfect Credibility and the Zero Lower Bound on the Nominal Interest Rate (June 1, 2010). Available at SSRN: http://ssrn.com/abstract=1649000

Contact Information

Martin Bodenstein (Contact Author)
Board of Governors of the Federal Reserve System ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
James Hebden
affiliation not provided to SSRN
Ricardo Cavaco Nunes
Federal Reserve Board ( email )
20th Street and Constitution Avenue NW
Washington, DC 20551
United States
Feedback to SSRN


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