The Macroeconomic Effects of Low and Falling Inflation at the Zero Lower Bound

49 Pages Posted: 12 Feb 2016

Date Written: November 26, 2015

Abstract

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

Suggested Citation

Neri, Stefano and Notarpietro, Alessandro, The Macroeconomic Effects of Low and Falling Inflation at the Zero Lower Bound (November 26, 2015). Bank of Italy Temi di Discussione (Working Paper) No. 1040. Available at SSRN: https://ssrn.com/abstract=2731709 or http://dx.doi.org/10.2139/ssrn.2731709

Stefano Neri (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy
+39 06 4792 2821 (Phone)

Alessandro Notarpietro

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

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