Monetary Policy, Asset-price Bubbles, and the Zero Lower Bound

Edited by Tim Robinson and Andrew Stone

in Monetary Policy with Very Low Inflation in the Pacific Rim

Published by University of Chicago Press

Published in print October 2006 | ISBN: 9780226378978
Published online February 2013 | e-ISBN: 9780226379012 | DOI:
Monetary Policy, Asset-price Bubbles, and the Zero Lower Bound

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This chapter imposes a zero lower bound (ZLB) on nominal interest rates, as a constraint on the actions of policymakers attempting to deal with a developing asset-price bubble. It provides the optimal monetary policy recommendations of activist and skeptical policymakers, through time, in the presence of an asset-price bubble. It concentrates on the period in which the bubble survives and grows. For an economy with lower responsiveness, it is observed that the effect of the ZLB on an activist policymaker's recommendations is correspondingly greater, when faced with an exogenous bubble. The data show that fears of encountering the ZLB should not be overstated, unless the neutral nominal interest rate in the economy is very low. Furthermore, there are three forms of “insurance” that a policymaker can take out against the risk of encountering the ZLB due to the future bursting of an asset-price bubble.

Keywords: zero lower bound; interest rates; asset-price bubble; monetary policy; policymaker; insurance

Chapter.  19618 words.  Illustrated.

Subjects: Business and Management

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