The Macroeconomic Effects of Low and Falling Inflation at the Zero Lower Bound
49 Pages Posted: 12 Feb 2016
Date Written: November 26, 2015
This paper assesses the macroeconomic consequences of a prolonged period of low and falling inflation when monetary policy is constrained by the zero lower bound (ZLB) on short-term nominal interest rates, the private sector is indebted in nominal terms (debt deflation mechanism) and nominal wages are downward rigid. Cost-push shocks that in normal circumstances would reduce inflation and stimulate output have contractionary effects on economic activity, once the ZLB interacts with the debt deflation mechanism. The contractionary effects are larger and more persistent when nominal wages cannot be reduced and when the private sector is highly indebted.
Keywords: DSGE models, zero lower bound, debt-deflation channel, downward nominal wage rigidities
JEL Classification: E21, E31, E37, E52
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