Gradualism and Liquidity Traps

Sebastian Schmidt and Taisuke Nakata

VfS Annual Conference 2016 (Augsburg): Demographic Change from Verein für Socialpolitik / German Economic Association

Abstract: Modifying the mandate of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy where large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the discretionary central bank with the standard mandate does, as in optimal commitment policy. Through expectations, the temporary overheating of the economy associated with such low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than half.

JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Gradualism and Liquidity Traps (2019)
Working Paper: Gradualism and liquidity traps (2016)
Working Paper: Gradualism and Liquidity Traps (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:vfsc16:145469

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