The Zero Bound on Nominal Interest Rates and Optimal Monetary Policy Under Discretion

24 Pages Posted: 3 May 2004

See all articles by Anton Nakov

Anton Nakov

European Central Bank (ECB); CEPR

Date Written: April 2, 2004

Abstract

I study how the zero bound on nominal interest rates affects optimal discretionary monetary policy within the standard New Keynesian framework. I find that the non-negativity constraint implies an optimal policy which is more expansionary and more aggressive near the zero bound compared to the optimal rule, which ignores this constraint. This "precautionary loosening" of monetary policy when the risk of deflation is high is required to offset the negative effect of private sector expectations on the current output gap and inflation. The effect is found to be quantitatively significant and to increase with the variance and persistence of the natural real interest rate.

Keywords: Zero bound, New Keynesian, optimal monetary policy

JEL Classification: E52, E47, E31

Suggested Citation

Nakov, Anton A., The Zero Bound on Nominal Interest Rates and Optimal Monetary Policy Under Discretion (April 2, 2004). Available at SSRN: https://ssrn.com/abstract=538922 or http://dx.doi.org/10.2139/ssrn.538922

Anton A. Nakov (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

CEPR ( email )

London
United Kingdom

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