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Risk shocks close to the zero lower bound

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  • Seneca, Martin

    (Bank of England)

Abstract

Large risk shocks give rise to cost-push effects in the canonical New Keynesian model. At the same time, monetary policy becomes less effective. Therefore, stochastic volatility introduces occasional trade-offs for monetary policy between inflation and output gap stabilisation. The cost-push effects operate through expectational responses to the interaction between shock volatility and the zero lower bound (ZLB) on interest rates. Optimal monetary policy calls for potentially sharp reductions in the interest rate when risk is elevated, even if this risk never materialises. Close to the ZLB, small risk shocks become ‘large’ in this sense. If policy is initially constrained by the ZLB, lift-off is optimally delayed when risk increases.

Suggested Citation

  • Seneca, Martin, 2016. "Risk shocks close to the zero lower bound," Bank of England working papers 606, Bank of England.
    • Handle: RePEc:boe:boeewp:0606
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    Cited by:

    1. Billi, Roberto M., 2018. "Price level targeting and risk management," Economic Modelling, Elsevier, vol. 73(C), pages 163-173.
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    3. Fernando M. Duarte & Benjamin K. Johannsen & Leonardo Melosi & Taisuke Nakata, 2020. "Strengthening the FOMC’s Framework in View of the Effective Lower Bound and Some Considerations Related to Time-Inconsistent Strategies," Finance and Economics Discussion Series 2020-067, Board of Governors of the Federal Reserve System (U.S.).
    4. Caggiano, Giovanni & Castelnuovo, Efrem & Pellegrino, Giovanni, 2017. "Estimating the real effects of uncertainty shocks at the Zero Lower Bound," European Economic Review, Elsevier, vol. 100(C), pages 257-272.

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    More about this item

    Keywords

    Risk shocks; uncertainty; zero lower bound on interest rates; optimal monetary policy;
    All these keywords.

    JEL classification:

    • 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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