TAILIEUCHUNG - The Zero Bound on Interest Rates and Optimal Monetary Policy ¤

This book provides detailed descriptions of the various money market instruments and the markets in which they are used. Where possible, the book tries to explain the historical forces that led to the development of an instrument, influenced its pattern of growth, and led to new forms of the instrument. A major focus in the book is the Federal Reserve, which, in addition to its monetary policy role, plays an important role as a regulator in a number of the markets. Much of the discussion in the book deals with the period. | The Zero Bound on Interest Rates and Optimal Monetary Policy Gauti Eggertsson Michael Woodford International Monetary Fund Princeton University June 26 2003 Abstract We consider the consequences for monetary policy of the zero floor for nominal interest rates. The zero bound can be a significant constraint on the ability of a central bank to combat deflation. We show in the context of an intertemporal equilibrium model that open-market operations even of unconventional types are ineffective if future policy is expected to be purely forward-looking. Nonetheless a credible commitment to the right sort of history-dependent policy can largely mitigate the distortions created by the zero bound. In our model optimal policy involves a commitment to adjust interest rates so as to achieve a time-varying price-level target when this is consistent with the zero bound. We also discuss ways in which other central-bank actions while irrelevant apart from their effects on expectations may help to make credible a central bank s commitment to its target We would like to thank Tamim Bayoumi Ben Bernanke Mike Dotsey Ben Friedman Stefan Gerlach Mark Gertler Marvin Goodfriend Ken Kuttner Maury Obstfeld Athanasios Orphanides Dave Small Lars Svensson Harald Uhlig Tsutomu Watanabe and Alex Wolman for helpful comments and the National Science Foundation for research support through a grant to the NBER. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. The consequences for the proper conduct of monetary policy of the existence of a lower bound of zero for overnight nominal interest rates has recently become a topic of lively interest. In Japan the call rate the overnight cash rate that is analogous to the federal funds rate in the . has been within 50 basis points of zero since October 1995 so that little room for further reductions in short-term nominal interest rates has existed since that time and has been .

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