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Monetary Policy in a Low Interest Rate World

Brookings papers on economic activity, 2017-04, Vol.2017 (1), p.317-372 [Peer Reviewed Journal]

Copyright © 2017 by THE BROOKINGS INSTITUTION ;Copyright © 2008 The Brookings Institution. ;Copyright Brookings Institution Press Spring 2017 ;ISSN: 0007-2303 ;ISSN: 1533-4465 ;EISSN: 1533-4465 ;DOI: 10.1353/eca.2017.0004

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Title:
Monetary Policy in a Low Interest Rate World
Author: KILEY, MICHAEL T. ; ROBERTS, JOHN M.
Subjects: Approaches ; Averages ; Banking ; Board of Governors of the Federal Reserve System ; Business cycles ; Central banks ; Consumer Price Index ; Econometric models ; Econometrics ; Economic activity ; Economic conditions ; Economic models ; Economic performance ; Economic stabilization ; Economic welfare ; Equilibrium ; Federal funding ; Federal funds rate ; Federal Reserve monetary policy ; Inflation ; Inflation rates ; Inflation targeting ; Interest rates ; Macroeconomic modeling ; Macroeconomics ; Modeling ; Monetary policy ; Nominal interest rates ; Output gaps ; Policy making ; Prescribed ; Price levels ; Prices ; Recessions ; Risk ; Risk adjustment ; Side effects ; Simulation ; Stability ; Standard deviation ; Steady state economies ; Unemployment
Is Part Of: Brookings papers on economic activity, 2017-04, Vol.2017 (1), p.317-372
Description: Nominal interest rates may remain substantially below the averages of the last half century, because central banks’ inflation objectives lie below the average level of inflation, and estimates of the real interest rate that are likely to prevail over the long run fall notably short of the average real interest rate experienced during this period. Persistently low nominal interest rates may lead to more frequent and costly episodes at the effective lower bound (ELB) on nominal interest rates. We revisit the frequency and potential costs of such episodes in a world of low interest rates, using both a dynamic stochastic general equilibrium (DSGE) model and the Federal Reserve’s largescale econometric model, the FRB/US model. Four main conclusions emerge. First, monetary policy strategies based on traditional, simple policy rules lead to poor economic performance when the equilibrium interest rate is low, with economic activity and inflation more volatile and systematically falling short of desirable levels. Moreover, the frequency and length of ELB episodes under such policy approaches are estimated to be significantly higher than in previous studies. Second, a risk adjustment to a simple rule—whereby monetary policymakers are more accommodative, on average, than prescribed by the rule—ensures that inflation averages its 2 percent objective, and requires that policymakers systematically seek inflation near 3 percent when the ELB is not binding. Third, commitment strategies, whereby monetary accommodation is not removed until either inflation or economic activity overshoots its longrun objective, are very effective in both the DSGE and FRB/US models. And fourth, our simulation results suggest that the adverse effects on economic and price stability associated with the ELB may be substantial at inflation targets near 2 percent if the equilibrium real interest rate is low and monetary policy follows a traditional approach. Whether such adverse effects could justify a higher inflation target depends upon the degree to which monetary policy strategies that differ substantially from such traditional approaches are feasible, and an assessment of a broader array of the inflation target’s effects on economic welfare.
Publisher: Washington: Brookings Institution Press
Language: English
Identifier: ISSN: 0007-2303
ISSN: 1533-4465
EISSN: 1533-4465
DOI: 10.1353/eca.2017.0004
Source: AUTh Library subscriptions: ProQuest Central

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Monetary Policy in a Low Interest Rate World

Copyright © 2017 by THE BROOKINGS INSTITUTION ;Copyright © 2008 The Brookings Institution. ;Copyright Brookings Institution Press Spring 2017 ;ISSN: 0007-2303 ;ISSN: 1533-4465 ;EISSN: 1533-4465 ;DOI: 10.1353/eca.2017.0004

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