Uncertainty at the Zero Lower Bound

38 Pages Posted: 4 Apr 2013

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Date Written: December 17, 2012

Abstract

This paper examines how the presence of uncertainty alters allocations and prices when the nominal interest rate is constrained by the zero lower bound. I conduct the analysis using a standard New Keynesian model in which the nominal interest rate is determined according to a truncated Taylor rule. I find that an increase in the variance of shocks to the discount factor process reduces consumption, inflation, and output by a substantially larger amount when the zero lower bound is binding than when it is not. Due to the zero lower bound constraint, policy functions for the real interest rates and the marginal costs of production are highly convex and concave, respectively. As a result, a mean-preserving spread in the shock distribution increases the expectation of future real interest rates and decreases the expectation of future real marginal costs, which lead forward-looking households and firms to reduce consumption and set lower prices today. The more flexible prices are, the larger the effects of uncertainty are at the zero lower bound.

Keywords: Occasionally binding constraints, liquidity trap, zero lower bound, uncertainty

JEL Classification: E32, E52, E61, E62, E63

Suggested Citation

Nakata, Taisuke, Uncertainty at the Zero Lower Bound (December 17, 2012). FEDS Working Paper No. 2013-09. Available at SSRN: https://ssrn.com/abstract=2244520 or http://dx.doi.org/10.2139/ssrn.2244520

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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