The Zero Lower Bound, the Dual Mandate, and Unconventional Dynamics

36 Pages Posted: 16 Feb 2013 Last revised: 29 Jun 2015

GavinEcon

Federal Reserve Bank of St. Louis - Research Division; University of Memphis Department of Economics

Benjamin D. Keen

University of Oklahoma - Department of Economics

Alexander W. Richter

Federal Reserve Bank of Dallas

Nathaniel A. Throckmorton

College of William and Mary

Date Written: March 18, 2015

Abstract

This article examines monetary policy when it is constrained by the zero lower bound (ZLB) on the nominal interest rate. Our analysis uses a nonlinear New Keynesian model with technology and discount factor shocks. Specifically, we investigate why technology shocks may have unconventional effects at the ZLB, what factors affect the likelihood of hitting the ZLB, and the implications of alternative monetary policy rules. We initially focus on a New Keynesian model without capital (Model 1) and then study that model with capital (Model 2). The advantage of including capital is that it introduces another mechanism for intertemporal substitution that strengthens the expectational effects of the ZLB. Four main findings emerge: (1) In Model 1, the choice of output target in the Taylor rule may reverse the effects of technology shocks when the ZLB binds; (2) When the central bank targets steady-state output in Model 2, a positive technology shock at the ZLB leads to more pronounced unconventional dynamics than in Model 1; (3) The presence of capital changes the qualitative effects of demand shocks and alters the impact of a monetary policy rule that emphasizes output stability; and (4) In Model 1, the constrained linear solution is a decent approximation of the nonlinear solution, but meaningful differences exist between the solutions in Model 2.

Keywords: Monetary Policy; Zero Lower Bound; Nonlinear Solution Method; Capital

JEL Classification: E31, E42, E58, E61

Suggested Citation

GavinEcon and Keen, Benjamin D. and Richter, Alexander W. and Throckmorton, Nathaniel A., The Zero Lower Bound, the Dual Mandate, and Unconventional Dynamics (March 18, 2015). Journal of Economic Dynamics and Control, Vol. 55, 2015. Available at SSRN: https://ssrn.com/abstract=2218575 or http://dx.doi.org/10.2139/ssrn.2218575

William T. Gavin (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

441 Locust Street
P. O. Box 442
St. Louis, MO 63166
United States
314 873-8422 (Phone)

HOME PAGE: http://www.gavinecon.com

University of Memphis Department of Economics ( email )

Memphis, TN 38152
United States

Benjamin D. Keen

University of Oklahoma - Department of Economics ( email )

729 Elm Avenue
Norman, OK 73019-2103
United States

Alexander W. Richter

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5360 (Phone)

HOME PAGE: http://alexrichterecon.com

Nathaniel A. Throckmorton

College of William and Mary ( email )

P.O. Box 8795
Williamsburg, VA 23187
United States

HOME PAGE: http://nathrockmorton.people.wm.edu/

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