Effective Monetary Policy Strategies in New Keynesian Models: A Reexamination

Chung, Hess; Herbst, Edward P.; Kiley, Michael T.

doi:10.1086/680629

Cited by 21 publications

(14 citation statements)

References 53 publications

(90 reference statements)

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“…It considers a decline in the policy interest rate of 100 basis points 12 quarters in the future, holding the nominal interest rate fixed at baseline before the 12th quarter and thereafter reverting to the policy rule. The power of forward guidance in DSGE models has been highlighted by a number of scholars, including Hess Chung, Edward Herbst, and Kiley (2015); Alisdair McKay, ; and Kiley (2016). The scale in the figure is held constant across the FRB/US and DSGE results to highlight the differences in the results.…”

Section: Percentmentioning

confidence: 99%

Monetary Policy in a Low Interest Rate World

Kiley¹,

Roberts²

2017

Brookings Papers on Economic Activity

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169

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Nominal interest rates may remain substantially below the averages of the last half century, because central banks' inflation objectives lie below the average level of inflation, and estimates of the real interest rate that are likely to prevail over the long run fall notably short of the average real interest rate experienced during this period. Persistently low nominal interest rates may lead to more frequent and costly episodes at the effective lower bound (ELB) on nominal interest rates. We revisit the frequency and potential costs of such episodes in a world of low interest rates, using both a dynamic stochastic general equilibrium (DSGE) model and the Federal Reserve's largescale econometric model, the FRB/US model. Four main conclusions emerge. First, monetary policy strategies based on traditional, simple policy rules lead to poor economic performance when the equilibrium interest rate is low, with economic activity and inflation more volatile and systematically falling short of desirable levels. Moreover, the frequency and length of ELB episodes under such policy approaches are estimated to be significantly higher than in previous studies. Second, a risk adjustment to a simple rule-whereby monetary policymakers are more accommodative, on average, than prescribed by the rule-ensures that inflation averages its 2 percent objective, and requires that policymakers systematically seek inflation near 3 percent when the ELB is not binding. Third, commitment strategies, whereby monetary accommodation is not removed until either inflation or economic activity overshoots its longrun objective, are very effective in both the DSGE and FRB/US models. And

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Section: Percentmentioning

confidence: 99%

Monetary Policy in a Low Interest Rate World

Kiley¹,

Roberts²

2017

Brookings Papers on Economic Activity

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169

168

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“…26 These results depend on the model specification and could be different in alternative models. For example, Chung, Herbst, and Kiley (2015) use DSGE models and report sizable and persistent overshooting of inflation following threshold policies for the unemployment rate that are less accommodative than the more aggressive strategies we consider; this result points to the possibility that inflation risks associated with these strategies could be greater than suggested by simulations of the FRB/US model. Forward guidance in the form of an unemployment rate threshold of 5.5 percent has no effect on the simulation results because, in our recession scenario, the unemployment rate is already below 5.5 percent by the time the asymmetric rule prescribes raising the federal funds rate above the ELB.…”

Section: Figure 3: Forward Guidance With Unemployment Rate Thresholdsmentioning

confidence: 77%

Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit

Chung

Gagnon

Nakata

et al. 2019

FEDS

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We simulate the FRB/US model and a number of statistical models to quantify some of the risks stemming from the effective lower bound (ELB) on the federal funds rate and to assess the efficacy of adjustments to the federal funds rate target, balance sheet policies, and forward guidance to provide monetary policy accommodation in the event of a recession. Over the next decade, our simulations imply a roughly 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. We also find that forward guidance and balance sheet polices of the kinds used in response to the Global Financial Crisis are modestly effective in speeding up the labor market recovery and return of inflation to 2 percent following an economic slump. However, these policies have only small effects in limiting the initial rise in the unemployment rate during a recession because of transmission lags. As with any model-based analysis, we also discuss a number of caveats regarding our results.

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“…In most cases, this welfare objective is different from the societal welfare objective function. Instead, we simply augment the policy rule of central bank with an additional objective following Chung, Herbst and Kiley (2015). Strict targets may be implemented without an explicit instrument rule Should monetary policy offset these hysteresis effects at the ZLB?…”

Section: Nominal Interest Ratementioning

confidence: 99%

“…Upon exit from the ZLB, the central bank keeps interest rate lower for two additional quarters to follow through with its promise and thus creates a boom in output and inflation. Because of procyclicality of as in Chung, Herbst and Kiley (2015). For example, they implement a nominal GDP target with an equation that sums price level and output gap (from flexible level) to zero.…”

Section: Nominal Interest Ratementioning

confidence: 99%

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Output Hysteresis and Optimal Monetary Policy

Garga

Singh

2018

SSRN Journal

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We analyze the implications for monetary policy when deficient aggregate demand can cause a permanent loss in potential output, a phenomenon termed as output hysteresis. In the model, incomplete stabilization of a temporary shortfall in demand reduces the return to innovation, thus reducing TFP growth and generating a permanent loss in output. Using a purely quadratic approximation to welfare under endogenous growth, we derive normative implications for monetary policy. Away from the zero lower bound (ZLB), optimal commitment policy sets interest rates to eliminate output hysteresis. A strict inflation targeting rule implements the optimal policy. However, when the nominal interest rate is constrained at the ZLB, strict inflation targeting is sub-optimal and admits output hysteresis. A new policy rule that targets output hysteresis returns the output to the pre-shock trend and approximates the welfare gains under optimal commitment policy. A central bank unable to commit to future policy actions suffers from hysteresis bias: it does not offset past losses in potential output.

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Effective Monetary Policy Strategies in New Keynesian Models: A Reexamination

Cited by 21 publications

References 53 publications

Monetary Policy in a Low Interest Rate World

Monetary Policy in a Low Interest Rate World

Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve's Current Policy Toolkit

Output Hysteresis and Optimal Monetary Policy

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