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Inflation Indexation and Zero Lower Bound

Author

Listed:
  • Daeha Cho

    (Hanyang University)

  • Eunseong Ma

    (Yonsei University)

Abstract

This study quantitatively assesses both the aggregate and disaggregate effects of inflation-indexed loan contracts using a heterogeneous agentNewKeynesian (HANK) model with an occasionally binding zero lower bound (ZLB). Substituting real for nominal government bonds reduces the volatility of output and inflation and decreases the frequency of ZLB events. Real loans sever the link between real interest rates and inflation, preventing a rise in real interest rates at the ZLB. Accordingly, ZLB events become less costly, weakening precautionary savings against aggregate risk. This leads to higher average nominal rates and a reduced frequency of ZLB occurrences, further reducing aggregate volatility. Although inflation indexation improves aggregate welfare, at the disaggregate level, the wealthy lose while the poor gain. Inflation indexation outperforms suggested policies aimed at providing more room for monetary policy, such as increasing the inflation target and implementing an asymmetric Taylor rule.

Suggested Citation

  • Daeha Cho & Eunseong Ma, 2024. "Inflation Indexation and Zero Lower Bound," Working papers 2024rwp-233, Yonsei University, Yonsei Economics Research Institute.
    • Handle: RePEc:yon:wpaper:2024rwp-233
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    Keywords

    Zero lower bound; HANK model; Inflation indexation; Welfare;
    All these keywords.

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • 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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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