The non-negative constraint on the nominal interest rate and the effects of monetary policy

Hasui, Kohei (2013): The non-negative constraint on the nominal interest rate and the effects of monetary policy.

Abstract

This paper analyzes the effects of monetary policy shock when there is a non-negative constraint on the nominal interest rate. I employ two algorithms: the piecewise linear solution and Holden and Paetz's (2012) algolithm (the HP algorithm). I apply these methods to a dynamic stochastic general equilibrium (DSGE) model which has sticky prices, sticky wages, and adjustment costs of investment. The main findings are as follows. First, the impulse responses obtained with the HP algorithm do not differ much from those obtained with the piecewise linear solution. Second, the non-negative constraint influences the effects of monetary policy shocks under the Taylor rule under some parameters. In contrast, the constraint has little effects on the response to money growth shocks. Third, wage stickiness contributes to the effects of the non-negative constraint through the marginal cost of the product. The result of money growth shock suggests that it is important to analyze the effects of the zero lower bound (ZLB) in a model which generates a significant liquidity effect.

• Item Type: MPRA Paper
• Language: English
• Keywords: Zero lower bound; Monetary policy shock; Wage stickiness; Liquidity effect
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E47 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E49 - Other; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Adam, K. and Billi, R. M. (2007) ``Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates,'' Journal of Monetary Economics, Vol. 54, No. 3, pp. 728-752, April.

Calvo, G A. (1983) ``Staggered prices in a utility-maximizing framework,'' Journal of Monetary Economics, Vol. 12, No. 3, pp. 383-398, September.

Christiano, L. J., Eichenbaum, M., and Rebelo, S. (2011) ``When Is the Government Spending Multiplier Large?'' Journal of Political Economy, Vol. 119, No. 1, pp. 78-121.

Christiano, L. J., Eichenbaum, M., and Evans, C. L. (1997) ``Sticky price and limited participation models of money: A comparison,'' European Economic Review, Vol. 41, No. 6, pp. 1201-1249, June.

Christiano, L. J., Eichenbaum, M., and Evans, C. L. (2005) ``Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,'' Journal of Political Economy, Vol. 113, No. 1, pp. 1-45, February.

Eggertsson, G.B. and Woodford, M. (2003) ``The Zero Bound on Interest Rates and Optimal Monetary Policy,'' Brookings Papers on Economic Activity, Vol. 34, No. 1, pp. 139-235.

Erceg, C. J., Henderson, D. W. and Levin, A. T. (2000) ``Optimal Monetary Policy with Staggered Wage and Price Contracts,'' Journal of Monetary Economics, Vol. 46, No. 2, pp. 281-313, October.

Fern\'andez-Villaverde, J., Gordon, G., Guerr\'on-Quintanan, P. A. and Rubio-Ram\'irez, J. (2012) ``Nonlinear Adventures at the Zero Lower Bound,'' NBER Working Papers 18058, National Bureau of Economic Research, Inc.

Fujiwara, I., Sudo, N. and Teranishi, Y. (2010) ``The Zero Lower Bound and Monetary Policy in a Global Economy: A Simple Analytical Investigation,'' International Journal of Central Banking, Vol. 6, No. 1, pp. 103-134, March.

Guerrieri, L., and Iacoviello, M. (2013) “Occbin: A Toolkit to Solve Models with Occasionally Binding Constraints Easily”, working paper, Federal Reserve Board

Holden, T. and Paetz, M. (2012) ``Efficient Simulation of DSGE Models with Inequality Constraints,'' Quantitative Macroeconomics Working Papers 21207b, Hamburg University, Department of Economics.

Ida, D. (2013) ``Optimal Monetary Policy Rules in a Two-Country Economy with a Zero Bound on Nominal Interest Rates,'' The North American Journal of Economics and Finance, Vol. 24, No. C, pp. 223-242.

Kato, R. and Nishiyama, S. (2005) ``Optimal Monetary Policy When Interest Rates Are Bounded at Zero,'' Journal of Economic Dynamics and Control, Vol. 29, No. 1-2, pp. 97-133, January.

Jung, T., Teranishi, Y. and Watanabe, T. (2005) ``Optimal Monetary Policy at the Zero-Interest-Rate Bound,'' Journal of Money, Credit and Banking, Vol. 37, No. 5, pp. 813-835, October.

Nakajima, T. (2008) ``Liquidity Trap and Optimal Monetary Policy in Open Economies,'' Journal of the Japanese and International Economies, Vol. 22, No. 1, pp. 1-33, March.

Nakata, T. (2012) ``Optimal Fiscal and Monetary Policy With Occasionally Binding Zero Bound Constraints,'' manuscript, New York University.

Nakov, A. (2008) ``Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate,'' International Journal of Central Banking, Vol. 4, No. 2, pp. 73-127, June.

Sims, C. A. (2002) ``Solving Linear Rational Expectations Models,'' Computational Economics, Vol. 20, No. 1-2, pp. 1-20, October.

Smets, F., and Wouters, R. (2003) ``An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area,'' Journal of the European Economic Association, Vol. 1, No. 5, pp. 1123-1175, 09.

Taylor, J. B. (1993) ``Discretion Versus Policy Rules in Practice,'' Carnegie-Rochester Conference Series on Public Policy, Vol. 39, No. 1, pp. 195-214, December.