Staff Reports
Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates
Number 887
May 2019 Revised August 2019

JEL classification: E52

Authors: Thomas M. Mertens and John C. Williams

This paper uses a standard New Keynesian model to analyze the effects and implementation of various monetary policy frameworks in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can eliminate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework that aims for above-target inflation during periods when policy is unconstrained. Second, dynamic strategies that raise inflation expectations by keeping interest rates “lower for longer” after periods of low inflation can both anchor expectations at the target level and further reduce the effects of the lower bound on the economy.

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AUTHOR DISCLOSURE STATEMENT(S)
Thomas M. Mertens
I declare that I have no relevant or material financial interests that relate to the research described in the paper "Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates."

John C. Williams
I declare that I have no relevant or material financial interests that relate to the research described in the paper "Tying Down the Anchor: Monetary Policy Rules and the Lower Bound on Interest Rates."