Monetary Policy under ZIRP

Though a lot has been written about ZIRP or Zero Interest Policy, but still there is always space for more.

Charles T. Carlstrom and Andrea Pescatori of Cleveland Fed have written a nice short article on monetary policy when interest rates are near zero:

This Economic Commentary explains the concerns that are associated with the combination of deflation, low economic activity, and zero nominal interest rates and describes some of the ways in which monetary policy might be conducted in this situation. We conclude by emphasizing that to be effective in an environment of zero short-term nominal interest rates, monetary policy needs to be unequivocally committed to avoiding expectations of deflation. We also argue that price-level targeting might be a good device for communicating such a commitment. While this policy prescription follows from the assumption that the zero interest rate bound is a consequence of a negative demand shock hitting the economy, it is worth stressing that falling prices can also be the consequence of a supply shock, namely particularly high productivity growth (not a bad thing!). This would clearly call for different policy actions than the ones described here.

Price Level targeting was first (and perhaps only) practiced by Sweden in 1930s. Since then it has been debated extensively but nothing much has happened in terms of policy action. Conceptually it looks superior than inflation rate targeting but there are practical difficulties.

Still, I think we need more research to make price level targeting more workable. Most research does not go beyond suggesting it as a measure.

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