Monetary Policy, Incomplete Information, and the Zero Lower Bound

41 Pages Posted: 6 Nov 2015

See all articles by Christopher J. Gust

Christopher J. Gust

Federal Reserve Board - Trade and Financial Studies

Benjamin Kramer Johannsen

Board of Governors of the Federal Reserve System

David Lopez-Salido

Board of Governors of the Federal Reserve System

Date Written: 2015-11-05

Abstract

In the context of a stylized New Keynesian model, we explore the interaction between imperfect knowledge about the state of the economy and the zero lower bound. We show that optimal policy under discretion near the zero lower bound responds to signals about an increase in the equilibrium real interest rate by less than it would when far from the zero lower bound. In addition, we show that Taylor-type rules that either include a time-varying intercept that moves with perceived changes in the equilibrium real rate or that respond aggressively to deviations of inflation and output from their target levels perform similarly to optimal discretionary policy. Our analysis of first-difference rules highlights that rules with interest rate smoothing terms carry forward current and past misperceptions about the state of the economy and can lead to suboptimal performance.

Suggested Citation

Gust, Christopher J. and Johannsen, Benjamin Kramer and Lopez-Salido, David, Monetary Policy, Incomplete Information, and the Zero Lower Bound (2015-11-05). FEDS Working Paper No. 2015-99. Available at SSRN: https://ssrn.com/abstract=2686984 or http://dx.doi.org/10.17016/FEDS.2015.099

Christopher J. Gust (Contact Author)

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Benjamin Kramer Johannsen

Board of Governors of the Federal Reserve System ( email )

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

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

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

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