Supply-side policies and the zero lower bound

This paper examines how supply-side policies may play a role in fighting a low aggregate demand that traps an economy at the zero lower bound (ZLB) of nominal interest rates. Future increases in productivity or reductions in mark-ups triggered by supply-side policies generate a wealth effect that pulls current consumption and output up. Since the economy is at the ZLB, increases in the interest rates do not undo this wealth effect, as we will have in the case outside the ZLB. The authors illustrate this mechanism with a simple two-period New Keynesian model. They discuss possible objections to this set of policies and the relation of supply-side policies with more conventional monetary and fiscal policies.Supply-side economics ; Keynesian economics

Misconceptions Regarding the Zero Lower Bound on Interest Rates

The paper reviews issues related to the zero lower bound (ZLB) on interest rates and argues that all of the following propositions are invalid: (1) in a ZLB situation, gshaping interest rate expectations is essentially the only tool that central bankers haveh (Bernanke, Reinhart, and Sack [2004]); (2) fiscal policy actions such as ghelicopter dropsh are in theory more effective than monetary policy actions; (3) the prominent gfoolproof wayh policy rule of Svensson (2001, 2003) is applicable more generally?that is, even when exact uncovered interest parity holds?than the alternative exchange rate rule of McCallum (2000); (4) both of the exchange rate strategies described in (3) are open to the objection that they constitute gbeggar-thy-neighborh approaches; and (5) there is a significant danger of ZLB difficulties stemming from a g deflationary traph type of equilibrium, as distinct from a gliquidity trap.hInterest rates; Zero lower bound; Quantitative easing; Expectations; Deflation trap; Liquidity trap

Expectations, deflation traps and macroeconomic policy

We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja, European Economic Review (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks that push interest rates to the zero lower bound, temporary increases in government spending can effectively insulate the economy from deflation traps.adaptive learning; monetary policy; fiscal policy; zero interest rate lower bound

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

Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates

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.nonlinear optimal policy, zero interest rate bound, commitment, liquidity trap, New Keynesian

Fiscal stimulus and distortionary taxation

We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (Smets and Wouters, 2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain, if they discount the future substantially. --Fiscal Stimulus,New Keynesian model,liquidity trap,zero lower bound,fiscal multiplier

Liquidity Trap Prevention and Escape: A Simple Proposition

Liquidity traps occur when the natural nominal interest rate becomes negative. In a model with capital price dynamics explicitly considered, we find that shocks in the future can cause current and lasting liquidity traps. We propose that the central bank can prevent or fix liquidity traps by appending to its inflation-targeting monetary policy with a prioritized promise to defend a lower bound of nominal capital price. (JEL E31, E43, E44, E52, E58, E61, G12) Keywords: Liquidity traps; Zero interest bound; Asset Prices; Lower capital price boundLiquidity traps; Zero interest bound; Asset Prices; Lower capital price bound

Optimal monetary policy under discretion with a zero bound on nominal interest rates

We determine optimal discretionary monetary policy in a New-Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such ‘preemptive easing’ is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the U.S. economy we ?nd the easing effect to be quantitatively important. Moreover, signi?cant welfare losses. Losses increase further when in?ation is partly determined by lagged in?ation in the Phillips curve. Targeting positive in?ation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear signi?cant and are much larger than in the case without lower bound. JEL Classification: C63 , E31 , E52liquidity trap, nonlinear policy, zero lower bound