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Are Nonlinear Methods Necessary at the Zero Lower Bound?

27 Pages Posted: 9 Aug 2016  

Alexander W. Richter

Federal Reserve Bank of Dallas

Nathaniel A. Throckmorton

College of William and Mary

Multiple version iconThere are 2 versions of this paper

Date Written: 2016-08-02

Abstract

This paper examines the importance of the zero lower bound (ZLB) constraint on the nominal interest rate by estimating three variants of a small-scale New Keynesian model: (1) a nonlinear model with an occassionally binding ZLB constraint; (2) a constrained linear model, which imposes the constraint in the filter but not the solution; and (3) an unconstrained linear model, which never imposes the constraint. The posterior distributions are similar, but important differences arise in their predictions at the ZLB. The nonlinear model fits the data better at the ZLB and primarily attributes the ZLB to a reduction in household demand due to discount factor shocks. In the linear models, the ZLB is due to large contractionary monetary policy shocks, which is at odds with the Fed’s expansionary policy during the Great Recession. Posterior predictive analysis shows the nonlinear model is partially able to account for the increase in output volatility and the negative skewness in output and inflation that occurred during the ZLB period, whereas the linear models predict almost no changes in those statistics. We also compare the results from our nonlinear model to the quasi-linear solution based on OccBin. The quasi-linear model fits the data better than the linear models, but it still generate too little volatility at the ZLB and predicts that a large policy shock caused the ZLB to bind in 2008Q4.

Keywords: Bayesian estimation, model comparison, zero lower bound, particle filter

JEL Classification: C11, E43, E58

Suggested Citation

Richter, Alexander W. and Throckmorton, Nathaniel A., Are Nonlinear Methods Necessary at the Zero Lower Bound? (2016-08-02). FRB of Dallas Working Paper No. 1606. Available at SSRN: https://ssrn.com/abstract=2820481 or http://dx.doi.org/10.24149/wp1606

Alexander W. Richter (Contact Author)

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5360 (Phone)

HOME PAGE: http://alexrichterecon.com

Nathaniel A. Throckmorton

College of William and Mary ( email )

P.O. Box 8795
Williamsburg, VA 23187
United States

HOME PAGE: http://nathrockmorton.people.wm.edu/

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