Infrequent but Long-Lived Zero Lower Bound Episodes and the Optimal Rate of Inflation

Countries rarely hit the zero lower bound (ZLB) on interest rates, but when they do, these episodes tend to be very long-lived. These two features are difficult to incorporate jointly into macroeconomic models using typical representations of shock processes. We introduce a regime-switching represen...

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Bibliographic Details
Published in:Annual review of economics 2016-01, Vol.8 (1), p.497-520
Main Authors: Dordal i Carreras, Marc, Coibion, Olivier, Gorodnichenko, Yuriy, Wieland, Johannes
Format: Article
Language:English
Subjects:
Inflation
Inflation rates
Interest rates
Keynesian theory
Macroeconomics
optimal inflation
Probability distribution
Representation
Risk
Risk premiums
Studies
zero lower bound
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Summary:Countries rarely hit the zero lower bound (ZLB) on interest rates, but when they do, these episodes tend to be very long-lived. These two features are difficult to incorporate jointly into macroeconomic models using typical representations of shock processes. We introduce a regime-switching representation of risk premium shocks into an otherwise standard New Keynesian model to generate a realistic distribution of ZLB durations. We discuss what different calibrations of this model imply for optimal inflation rates.
ISSN:1941-1383
1941-1391
DOI:10.1146/annurev-economics-080315-015306