Optimal Monetary Policy Mix at the Zero Lower Bound

Abstract

We study optimal monetary policy at the zero lower bound in a model where the central bank can deploy forward guidance and balance-sheet policies. A welfare-maximising monetary authority should stabilise inflation and output, avoiding large countercyclical balance-sheet changes, which increase inequality between the households holding long-term debt and those who do not. Since the two policies are partially complementary and separately unable to neutralise adverse demand shocks fully, the optimal policy is a mix of the two instruments. This consists of a shorter ZLB duration and milder balance-sheet adjustments than if the central bank could only use a single instrument.

Keywords: Optimal monetary policy, Unconventional monetary policy, Forward guidance, Quantitative easing

JEL Classification: E52, E58, E61