On the Function of the Zero Interest Rate Commitment: Monetary Policy Rules in the Presence of the Zero Lower Bound on Interest Rates

Bank of Japan Working Paper No. 05-E-1

58 Pages Posted: 16 Feb 2005

See all articles by Nobuyuki Oda

Nobuyuki Oda

Bank of Japan - Institute for Monetary and Economic Studies; Kyorin University

Takashi Nagahata

Bank of Japan - Institute for Monetary and Economic Studies

Date Written: February 2005

Abstract

We analyze the effectiveness of monetary policy rules in the presence of the zero lower bound on nominal interest rates, using stochastic simulations.

Specifically, we assume a small structural model composed of the IS and AS curves with both forward-looking and backward-looking agents, and estimate the model using Japanese economic data. Based on the results, we investigate which monetary policy rule is superior, in terms of minimizing social loss, among various policy rules which take the zero lower bound constraint into account. We assume a simple Taylor-type monetary policy rule estimated using the data before the zero interest rate policy was adopted as the baseline policy rule. We then modify this policy rule by adding a policy commitment whereby if deflation occurs the zero interest rate policy will be maintained until the rate of inflation rises beyond a specific level.

The analyses indicate that such policy rules can be effective if the contents of the commitment - that is, the conditions for maintaining the zero interest rate policy - are set appropriately based on the economic conditions when the commitment is implemented. We also find that monetary policy rules with a nonlinearity, whereby preemptive monetary easing is appropriately implemented as the nominal interest rate approaches zero, perform well if they are regarded as credible, even without any explicit policy commitment.

Keywords: Zero interest rate commitment, zero lower bound on nominal interest rates, preemptive monetary easing, monetary policy rule, optimal simple rule, stochastic simulation

JEL Classification: E52, E58

Suggested Citation

Oda, Nobuyuki and Oda, Nobuyuki and Nagahata, Takashi, On the Function of the Zero Interest Rate Commitment: Monetary Policy Rules in the Presence of the Zero Lower Bound on Interest Rates (February 2005). Bank of Japan Working Paper No. 05-E-1, Available at SSRN: https://ssrn.com/abstract=667661 or http://dx.doi.org/10.2139/ssrn.667661

Nobuyuki Oda

Bank of Japan - Institute for Monetary and Economic Studies ( email )

Mitaka-shi, Tokyo
Japan

Kyorin University ( email )

Mitaka-shi, Tokyo
Japan

Takashi Nagahata (Contact Author)

Bank of Japan - Institute for Monetary and Economic Studies ( email )

2-1-1, Hongoku-cho
Nihonbashi
Chuo-ku, Tokyo, 103
Japan

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