Uncertainty and the Zero Lower Bound: A Theoretical Analysis

MPRA Paper from University Library of Munich, Germany

Abstract: This paper demonstrates how to analytically characterize the set of rational expectations equilibria in a simple stochastic New Keynesian model with the zero lower bound. In this environment, purely forward-looking (non-history-dependent) monetary policies are not generally consistent with existence of rational expectations equilibria. In particular, equilibria exist only when the volatility of the shocks is below some threshold level. This non-existence result is a consequence of the fact that the expected average policy rate rises with the level of uncertainty in the presence of the zero lower bound under forward-looking policies. History-dependent policies can be designed to eliminate the tendency of the expected average policy rate to rise with uncertainty, thereby potentially mitigating the non-existence problems. The non-existence results are likely quite robust, as the only structural feature of the economy upon which they depend is the Fisher condition.

Keywords: Monetary Policy; Zero Lower Bound; New Keynesian Models (search for similar items in EconPapers)
JEL-codes: E3 E4 E5 E52 E58 (search for similar items in EconPapers)
Date: 2011-02-22
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