Finance and Economics Discussion Series (FEDS)
September 1999
Three Lessons for Monetary Policy in a Low Inflation Era
David L. Reifschneider and John C. Williams
Abstract:
The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound.
Full paper (4750 KB Postscript)Keywords: Monetary policy, macroeconomic models, liquidity trap
PDF: Full Paper
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