Risk Management for Monetary Policy Near the Zero Lower Bound

65 Pages Posted: 3 Jun 2015

See all articles by Charles L. Evans

Charles L. Evans

Federal Reserve Bank of Chicago - Research Department

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department

Francois Gourio

Federal Reserve Bank of Chicago

Spencer D. Krane

Federal Reserve Bank of Chicago - Economic Research

Date Written: May 21, 2015

Abstract

As projections have inflation heading back toward target and the labor market continuing to improve, the Federal Reserve has begun to contemplate an increase in the federal funds rate. There is however substantial uncertainty around these projections. How should this uncertainty affect monetary policy? In many standard models uncertainty has no effect. In this paper, we demonstrate that the zero lower bound on nominal interest rates implies that the central bank should adopt a looser policy when there is uncertainty. In the current context this result implies that a delayed liftoff is optimal. We demonstrate this result theoretically in two canonical macroeconomic models. Using numerical simulations of our models, calibrated to the current environment, we find optimal policy calls for 2 to 3 quarters delay in liftoff relative to a policy that does not take into account uncertainty about policy being constrained by the ZLB. We then use a narrative study of Federal Reserve communications and estimated policy reaction functions to show that risk management is a longstanding practice in the conduct of monetary policy.

Keywords: monetary policy, risk management, zero lower bound

JEL Classification: E52, E58

Suggested Citation

Evans, Charles L. and Fisher, Jonas D. M. and Gourio, Francois and Krane, Spencer D., Risk Management for Monetary Policy Near the Zero Lower Bound (May 21, 2015). FRB of Chicago Working Paper No. 2015-03, Available at SSRN: https://ssrn.com/abstract=2613535 or http://dx.doi.org/10.2139/ssrn.2613535

Charles L. Evans

Federal Reserve Bank of Chicago - Research Department ( email )

230 South LaSalle Street
P.O. Box 834
Chicago, IL 60604-1413
United States
312-322-5812 (Phone)
312-322-2357 (Fax)

Jonas D. M. Fisher (Contact Author)

Federal Reserve Bank of Chicago - Economic Research Department ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States

Francois Gourio

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

HOME PAGE: http://sites.google.com/site/fgourio

Spencer D. Krane

Federal Reserve Bank of Chicago - Economic Research ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States
312-322-2382 (Phone)

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