Animal spirits, risk premia and monetary policy at the zero lower bound

Abstract

In this paper we investigate the risk-related effects of monetary policy in normal times, as well as in periods where the zero lower bound (ZLB) binds, in a stylized macroeconomic model with boundedly rational beliefs. In our model, financial market participants use heuristics to assess the risk premium over the policy rate in accordance to an "implicit Taylor rule" that measures the stance of conventional monetary policy and which serves as an informative instrument during times when the funds rate is constrained by the ZLB. In such a case, conventional monetary policy is exhausted so that the central bank is forced to use unconventional types of policy. We propose alternative monetary policy measures to help the economy out of the liquidity trap which take into account this assumed form of bounded rationality.

Monetary Policy with a State-Dependent Inflation Target in a Behavioral Two-country Monetary Union Model

“…More specifically, we consider a two-country version of the behavioral macroeconomic framework studied in Proaño and Lojak (2020). As there we specify here the behavioral equations of the macroeconomic variables in terms of log deviations from their respective long-run equilibrium values to focus on the nonlinear dynamics of the agents' boundedly rational perceptions.…”

“…As Proaño and Lojak (2020) (see also De Grauwe, 2012), we assume that the aggregate expectations of households concerning their consumption expectations are determined through…”

“…This "shadow rate rule" would reflect the cumulative deviations of inflation and output from their respective targets during the ZLB episode, being this history-dependent in a similar way as a price-level targeting rule would be at least during the ZLB period. In a similar approach, Proaño and Lojak (2020) use the ZLB policy rate gap -defined as the spread between the policy rate and the hypothetical Taylor rule rate which would prevail if the ZLB was not bindingas a measure for lack of conventional monetary policy accommodation which affects the risk perception of the market participants, leading to higher risk premia and thus to a deterioration of the financing conditions of households and the government which in turn prolongs the ZLB episode.…”

“…The remainder of the paper is organized as follows. In section 2 we describe the behavioral two-country monetary union model based on Proaño and Lojak (2020) and similar in spirit to Bertasuite et al (2020). In section 3 we discuss the results of our numerical analysis both concerning the short-run dynamics of the model as well as its medium-run properties under a constant inflation target and under a state-dependent inflation target.…”

Essays in Financial Macroeconomics: Corporate Debt, Systemic Risk and Macrofinancial Stability

“…Second, policy makers should take into account the cognitive limitations of economic agents when they conduct their policies. As it is shown in Proaño and Lojak (2019), the supplementation of a simple Taylor rule by e.g. market risk premium measures, which take the agents' (mis-)perceptions into account, can be quite successful in stabilizing the economy.…”