Abstract: This paper shows that under a strict inflation targeting regime, the government spending multiplier at the zero lower bound (ZLB) is larger under sticky information than under sticky prices. Similarly, well known paradoxes, e.g., the paradox of toil and the paradox of flexibility become more severe under sticky information. For the case of sticky information it is important to assume that the fiscal policy intervention coincides with the duration of zero interest rates, while such a distinction is less important for sticky prices. We unify and clarify results that may appear to contradict each other in the literature.

Output Hysteresis & Optimal Monetary Policy (with Sanjay R. Singh)

Journal of Monetary Economics, Forthcoming

Abstract: We derive a fully quadratic approximation to welfare under endogenous growth and study optimal monetary policy. Away from the ZLB, optimal commitment policy sets interest rates to eliminate output hysteresis. A strict inflation targeting rule implements the optimal policy. At the ZLB, strict inflation targeting is sub-optimal and admits output hysteresis, defined as a permanent loss in potential output. A new policy rule that targets output hysteresis returns the output to the pre-shock trend and approximates the welfare gains under optimal commitment policy. A central bank unable to commit to future policy actions suffers from hysteresis bias: it does not offset past losses in potential output.

Policy citation:  Tobias Adrian, Director of Monetary and Capital Markets Department at the IMF (September 7, 2018)

Disclaimer: The views expressed herein are those of the author(s) and do not indicate concurrence by the Federal Reserve Bank of Boston, the principals of the Board of Governors, or the Federal Reserve System.