Staggered Price Setting and the Zero Bound on Nominal Interest Rates

24 Pages Posted: 21 Nov 2012

Date Written: 1998

Abstract

Does the zero bound on nominal interest rates constitute an argument against low inflation? The Federal Reserve implements monetary policy with nominal interest rates, which tend to be low when inflation is low. However, in an optimizing model with staggered price setting, the zero bound does not hinder real economic activity — and thus does not constitute an argument against low inflation — for two reasons. First, low nominal interest rates promote efficient money holdings, and second, even when the nominal interest rate is zero, the real interest rate can fall if the monetary authority can engineer temporarily higher expected inflation.

Suggested Citation

Wolman, Alexander L., Staggered Price Setting and the Zero Bound on Nominal Interest Rates (1998). FRB Richmond Economic Quarterly, vol. 84, no. 4, Fall 1998, pp. 1-24. Available at SSRN: https://ssrn.com/abstract=2126287

Alexander L. Wolman (Contact Author)

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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