No abstract

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB US model to quantify the e ects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these e ects. During particularly severe contractions, open-market operations alone may be insu cient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero in ation rate, there is a signi cant increase in the variability of output but not in ation. However, a simple modi cation to the Taylor rule yields a dramatic reduction in the detrimental e ects of the zero bound.

The zero lower bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. We use the FRB US model to quantify the e ects of the bound on macroeconomic stabilization and to explore how policy can be designed to minimize these e ects. During particularly severe contractions, open-market operations alone may be insu cient to restore equilibrium; some other stimulus is needed. Abstracting from such rare events, if policy follows the Taylor rule and targets a zero in ation rate, there is a signi cant increase in the variability of output but not in ation. However, a simple modi cation to the Taylor rule yields a dramatic reduction in the detrimental e ects of the zero bound.