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Deflationary Shocks and Monetary Rules: an Open-Economy Scenario Analysis

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Author Info
Douglas Laxton
Papa N'Diaye
Paolo Pesenti

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Abstract

The paper considers the macroeconomic transmission of demand and supply shocks in an open economy under alternative assumptions on whether the zero interest floor (ZIF) is binding. It uses a two-country general-equilibrium simulation model calibrated to the Japanese economy vis-a-vis the rest of the world. Negative demand shocks have more prolonged and startling effects on the economy when the ZIF is binding than when it is not binding. Positive supply shocks can actually extend the period of time over which the ZIF may be expected to bind. More open economies hit the ZIF for a shorter period of time, and with less harmful effects. Deflationary supply shocks have different implications according to whether they are concentrated in the tradables rather than the nontradables sector. Price-level-path targeting rules are likely to provide better guidelines for monetary policy in a deflationary environment, and have desirable properties in normal times when the ZIF is not binding.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12703.

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Date of creation: Nov 2006
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Handle: RePEc:nbr:nberwo:12703

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Find related papers by JEL classification:
E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Svensson, Lars E O, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," CEPR Discussion Papers 2566, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June. [Downloadable!] (restricted)
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  9. Nicoletta Batini & Papa M'B. P. N'Diaye & Alessandro Rebucci, 2005. "The Domestic and Global Impact of Japan's Policies for Growth," IMF Working Papers 05/209, International Monetary Fund. [Downloadable!]
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  10. Gauti Eggertsson & Michael Woodford, 2004. "Optimal monetary and fiscal policy in a liquidity trap," Discussion Papers 0405-02, Columbia University, Department of Economics. [Downloadable!]
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  11. Ben Hunt & Douglas Laxton, 2001. "The Zero Interest Rate Floor (ZIF) and its Implications for Monetary Policy in Japan," IMF Working Papers 01/186, International Monetary Fund. [Downloadable!]
  12. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2003. "The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
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  13. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  14. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March. [Downloadable!]
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