Modeling Macroeconomic Policymakers’ Interactions under Zero Lower Bound Environment: The New Keynesian Theoretical Approach

Abstract

The paper examines how the implicit coordination mechanisms between the policymakers could help in overcoming negative macroeconomic consequences which are provoked by the problem of zero lower bound (ZLB) on the nominal interest rates. For the long period of time, before the global recession started, the ZLB problem was not found to be interesting for researchers. Immediately after the crisis outbreak, more attention was put on that problem within different approaches since conventional monetary policy faced substantial limitation in overcoming business cycles. Many authors have proposed new unconventional measures in both monetary policy and fiscal policy sphere. The theoretical approaches to the ZLB problem include many different aspects. In the paper we chose to use regime switching models adjusted to simulate occasionally binding constraints in order to investigate different scenarios within the New Keynesian framework. We found that coordination between more passive monetary policymaker and more active fiscal policymaker is crucial in the ZLB environment. Central bank has to follow monetary policy rule in which both inflation stabilization and output stabilization have certain positive weight. However, credible policy-making which is supported by the relevant institutions is a necessary precondition for implicit coordination, which substantially decrease the losses occurred as a consequence of ZLB on interest rates.

Monetary Policy after the Great Moderation

“…The use of these tools, helped by new technologies, is a way of achieving credibility, but it reduces the policy relevance of other more important variables in the central banking practice as the economic interactions. Lehtimäki Praščević and Ješić (2019), central bankers have to follow accurate monetary policies in order to achieve the stabilization of inflation and output, but a precondition to this is a credible policy-making, which could miti-gate negative consequences of the recent very low interest rates. For the sake of financial stability, fiscal policy can be also used (Dumičić, 2019).…”

The Quality of Public Finance in the Countries of South-East Europe

“…Countries with weak institutional structures, as is the case here, are much more vulnerable to crises, which are, among other things, measured by the decline of production and other economic indicators. Praščević & Ješić (2018), indicate that weak institutions, as well, provide the outcomes that are extremely sensitive to the shocks, which could make the collaboration between the policymakers impossible to sustain. Regarding the public finances, it is important to note that institutions limit policy dominance (Acemoglu, D., Jonhson S. and Robinson J.…”

New Keynesian Liquidity Trap and Conventional Fiscal Stance: An Estimated DSGE Model

“…This calls for policy re-evaluation and coordination. Praščević & Ješić (2019) have recently suggested an unconventional monetary policy to break the episodes of ZLB and its macroeconomic consequences. Interestingly, our paper derives economic implications from different levels of fiscal involvement in such an interest rate environment.…”