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

39 Pages Posted: 23 Mar 2007

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 on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-à-vis the rest of the world. Negative demand shocks have more prolonged and startling 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. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than 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). CEPR Discussion Paper No. 5997. Available at SSRN: https://ssrn.com/abstract=976063

Douglas Laxton (Contact Author)

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

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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