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Monetary policy rules and zero lower bound on nominal interest rates in a cost-channel economy

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  • Pathberiya, Lasitha R.C.

Abstract

This study analyzed monetary policy rules in a cost-channel economy with a zero lower bound on nominal interest rates (ZLB). The cost channel reflects the supply-side effects of the monetary policy. The ZLB is considered an occasionally binding constraint in a new Keynesian setting. Taylor-type interest rules represent the monetary policy rules, and the novel forward guidance rule introduced in this study is anticipated and endogenous. Under monetary policy rules, a cost-channel economy is more likely to fall into a liquidity trap and remain there longer than a no-cost-channel economy. Accordingly, monetary policy transmission differs from that in a no-cost-channel economy in the ZLB presence. Furthermore, if agents expect future recessions, achieving the inflation target is more challenging in cost-channel economies. Irrespective of the existence of a cost channel, the forward guidance rule reduces the frequency and depth of liquidity-trapped recessions compared to the Taylor-type rules and avoids deflation bias.

Suggested Citation

  • Pathberiya, Lasitha R.C., 2024. "Monetary policy rules and zero lower bound on nominal interest rates in a cost-channel economy," Economic Modelling, Elsevier, vol. 139(C).
    • Handle: RePEc:eee:ecmode:v:139:y:2024:i:c:s0264999324001640
    DOI: 10.1016/j.econmod.2024.106808
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    Keywords

    Cost channel of monetary policy; Zero rates on nominal interest rates; Interest rate rules; Forward guidance rules; Inflation bias; Deflation bias;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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