Optimal monetary policy under commitment with a zero bound on nominal interest rates : [Version: May 7, 2004]

We determine optimal monetary policy under commitment in a forwardlooking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not require targeting a positive average rate of inflation. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) mark-up shocks. JEL Klassifikation: C63, E31, E52

The Optimal Inflation Buffer with a Zero Bound on Nominal Interest Rates

This paper characterizes the optimal inflation buffer consistent with a zero lower bound on nominal interest rates in a New Keynesian sticky-price model. It is shown that a purely forward-looking version of the model that abstracts from inflation inertia would significantly underestimate the inflation buffer. If the central bank follows the prescriptions of a welfare-theoretic objective, a larger buffer appears optimal than would be the case employing a traditional loss function. Taking also into account potential downward nominal rigidities in the price-setting behavior of firms appears not to impose significant further distortions on the economyinflation inertia, downward nominal rigidity, nonlinear policy, liquidity trap

Phase equilibrium of liquid water and hexagonal ice from enhanced sampling molecular dynamics simulations

We study the phase equilibrium between liquid water and ice Ih modeled by the TIP4P/Ice interatomic potential using enhanced sampling molecular dynamics simulations. Our approach is based on the calculation of ice Ih-liquid free energy differences from simulations that visit reversibly both phases. The reversible interconversion is achieved by introducing a static bias potential as a function of an order parameter. The order parameter was tailored to crystallize the hexagonal diamond structure of oxygen in ice Ih. We analyze the effect of the system size on the ice Ih-liquid free energy differences and we obtain a melting temperature of 270 K in the thermodynamic limit. This result is in agreement with estimates from thermodynamic integration (272 K) and coexistence simulations (270 K). Since the order parameter does not include information about the coordinates of the protons, the spontaneously formed solid configurations contain proton disorder as expected for ice Ih.Comment: 9 pages, 6 figure

Output gaps and monetary policy at low interest rates

Policymakers use various indicators of economic activity to assess economic conditions and set an appropriate stance for monetary policy. A key challenge for policymakers is finding indicators that give a clear and accurate signal of the state of the economy in real time—that is, at the time policy is actually made. Unfortunately, most indicators are initially estimated based on incomplete information and subsequently revised as more information becomes available. Moreover, some indicators are based on economic concepts that are not directly observable. ; Two indicators of economic activity often used to guide monetary policy are the output gap and the growth rate of real GDP. The output gap measures how far the economy is from its full employment or “potential” level. The output gap is a noisy signal of economic activity, however, because it depends on potential GDP, which is unobservable, and because it depends on estimates of GDP that are subject to revision. In contrast, estimates of GDP growth have the advantage of being observable—albeit with a lag. But these estimates are also subject to revision as more and better underlying information becomes available. Given the possibility that either of the indicators could give an inaccurate signal in real time, should one indicator be favored over the other as a guide for policy? ; Billi uses a standard model to compare economic performance under a policy that focuses on the output gap with one that focuses on GDP growth. He concludes that policymakers should usually focus on the output gap as an indicator of economic activity when policy rates are constrained by the ZLB. A policy that focuses on GDP growth can lead to more frequent encounters with the ZLB, which, in turn, lead to more volatility in output and inflation. In failing to account for the ZLB, previous research overstated the effectiveness of a policy that focuses on GDP growth.

Does Employment Protection Inhibit Technical Diffusion?

I ask whether differences in labor market performance between the US and Europe can be attributed to an interaction between employment protection legislation (EPL) and an acceleration in the rate of capital-embodied technical change associated with the advent of information technologies. I find that EPL is associated with a slowing in the diffusion of new technologies. I also find that an acceleration in the rate of embodied technical change has a negligible effect on employment in an undistorted economy. In addition, in the presence of EPL, employment decreases in the long run after such a shockembodiment, vintage capital, dismissal costs, employment protection, information technology

Entry, Exit and Investment-Specific Technical Change, Second Version

Using European data, this paper finds that (1) industry entry and exit rates are positively related to industry rates of investment-specific technical change (ISTC); (2) the sensitivity of industry entry and exit rates to cross-country differences in entry costs depends on industry rates of ISTC. The paper constructs a general equilibrium model in which the rate of ISTC varies across industries and new investment-specific technologies can be introduced by entrants or by incumbents. In the calibrated model, equilibrium behavior is consistent with stylized facts (1) and (2), provided the cost of technology adoption is increasing in the rate of ISTC.Entry, exit, turnover, investment-specific technical change, entry costs, vintage capital, embodied technical change, lumpy investment

Was monetary policy optimal during past deflation scares?

Countries around the world have fallen into one of the deepest recessions since the Great Depression—a recession exacerbated by a severe financial crisis. Among the challenges that face monetary policymakers in such uncertain times is the danger that economies worldwide, including the United States, Japan, and the Euro Area, may enter a period of deflation, in which the prices of goods and services fall relentlessly. ; Policymakers and economists agree that sustained deflation would likely worsen the already fragile economic and financial environment. Past episodes of deflation in the wake of financial crises have included falling asset values, collapsing business and consumer confidence, credit crunches, widespread bankruptcies, long-lasting surges in unemployment, and other adverse conditions. Moreover, a deflationary environment has the potential to complicate the conduct of monetary policy. ; Policymakers have responded vigorously to the current crisis to prevent deflation. Some analysts warn that the U.S. policy response might be too proactive and cause a subsequent surge in inflation. At the same time, other analysts advise that the policy response in many other countries might not be active enough to fend off deflation. Of course, it is too early to judge the success of the different policies in the current episode. Still, it is possible to learn from past attempts by policymakers to fend off deflation under similar economic circumstances. ; Billi shows how Taylor rules can be used to evaluate monetary policy. He then compares actual policy during past deflation scares—in Japan in the 1990s and in the United States in the 2000s—with how policy would have been conducted using Taylor rules based, to the extent possible, on data available at the time. The rule-based evidence suggests that Japan’s monetary policy response during its deflation scare might have been too weak, while the U.S. response might have been too strong.