Three Lessons for Monetary Policy In a Low Inflation Era
Federal Reserve Board - Division of Research and Statistics
John C. Williams
Federal Reserve Bank of San Francisco
August 26, 1999
FEDS Working Paper No. 99-44
The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound.
Number of Pages in PDF File: 48
JEL Classification: E52, F41
Date posted: November 16, 1999
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