Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy

53 Pages Posted: 4 Jan 2016

See all articles by Susanto Basu

Susanto Basu

Boston College, College of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Brent Bundick

Federal Reserve Bank of Kansas City

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Date Written: December 2015

Abstract

At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.

Suggested Citation

Basu, Susanto and Bundick, Brent, Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy (December 2015). NBER Working Paper No. w21838, Available at SSRN: https://ssrn.com/abstract=2710510

Susanto Basu (Contact Author)

Boston College, College of Arts and Sciences, Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Brent Bundick

Federal Reserve Bank of Kansas City ( email )

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Kansas City, MO 64198
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