Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries

S. Borağan Aruoba · Pablo A. Cuba-Borda · Frank Schorfheide

96 citations0/0 files storedInternational Finance Discussion Paper

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

We compute a sunspot equilibrium in an estimated small-scale New Keynesian model with a zero lower bound (ZLB) constraint on nominal interest rates and a full set of stochastic fundamental shocks. In this equilibrium a sunspot shock can move the economy from a regime in which inflation is close to the central bank's target to a regime in which the central bank misses its target, inflation rates are negative, and interest rates are close to zero with high probability. A nonlinear filter is used to examine whether the U.S. in the aftermath of the Great Recession and Japan in the late 1990s transitioned to a deflation regime. The results are somewhat sensitive to the model specification, but on balance, the answer is affirmative for Japan and negative for the U.S.

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References

2004Interest and Prices 2011When Is the Government Spending Multiplier Large?2003Zero Bound on Interest Rates and Optimal Monetary Policy 2007Bayesian Analysis of DSGE Models 1983Do Sunspots Matter?2003The Zero Bound on Interest Rates and Optimal Monetary Policy 2001The Perils of Taylor Rules 2011What Fiscal Policy Is Effective at Zero Interest Rates?

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