Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis

37 Pages Posted: 6 Dec 2006

See all articles by Douglas Laxton

Douglas Laxton

International Monetary Fund (IMF) - Research Department

Papa N'Diaye

International Monetary Fund (IMF) - Asia and Pacific Department

Paolo A. Pesenti

Federal Reserve Bank of New York; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: December 2006

Abstract

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions about whether the zero interest rate floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy relative to the rest of the world. Negative demand shocks have more prolonged and conspicuous effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. Economies that are more open hit the ZIF for a shorter period of time, and with less harmful effects. The implications of deflationary supply shocks depend on whether the shocks are concentrated in the tradables or the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.

Keywords: deflation, monetary policy rules, zero interest rate floor

JEL Classification: E17, E52, F41

Suggested Citation

Laxton, Douglas and N'Diaye, Papa and Pesenti, Paolo A., Deflationary Shocks and Monetary Rules: An Open-Economy Scenario Analysis (December 2006). FRB of New York Staff Report No. 267. Available at SSRN: https://ssrn.com/abstract=949600 or http://dx.doi.org/10.2139/ssrn.949600

Douglas Laxton

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Papa N'Diaye

International Monetary Fund (IMF) - Asia and Pacific Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Paolo A. Pesenti (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5493 (Phone)
212-720-6831 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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