Faculty of Economics and Business Administration Publications Database

Exchange Rate Policy and the Zero Bound on Nominal Interest Rates

Coenen, Günter
Volume: 94
Number: 2
Pages: 80 - 84
Month: 5
ISSN-Print: 2574-0768
Year: 2004
Keywords: Monetary policy rules; Zero-interest-rate bound; Liquidity trap; Rational expectations; Nominal rigidities; Exchange rates; Monetary transmission
Abstract: In this paper, we study the effectiveness of monetary policy in a severe recession and deflation when nominal interest rates are bounded at zero. We compare two alternative proposals for ameliorating the effect of the zero bound: an exchange-rate peg and price-level targeting. We conduct this quantitative comparison in an empirical macroeconometric model of Japan, the United States and the euro area. Furthermore, we use a stylized micro-founded two-country model to check our qualitative findings. We find that both proposals succeed in generating inflationary expectations and work almost equally well under full credibility of monetary policy. However, price-level targeting may be less effective under imperfect credibility, because the announced price-level target path is not directly observable.