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Three Lessons for Monetary Policy in a Low-Inflation Era

David Reifschneider and John C. Williams
Journal of Money, Credit and Banking
Vol. 32, No. 4, Part 2: Monetary Policy in a Low-Inflation Environment (Nov., 2000), pp. 936-966
DOI: 10.2307/2601151
Stable URL: http://www.jstor.org/stable/2601151
Page Count: 31
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Three Lessons for Monetary Policy in a Low-Inflation Era
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Abstract

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB/US model to quantify the effects of the zero bound on macroeconomic stabilization and to explore how policy can be designed to minimize these effects. During particularly severe contractions, open-market operations alone may be insufficient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero-inflation rate, there is a significant increase in the variability of output but not inflation. However, a simple modification to the Taylor rule yields a dramatic reduction in the detrimental effects of the zero bound.

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