Risk Premium Shocks and the Zero Bound on Nominal Interest Rates

Authors


  • We thank Steve Ambler, Craig Burnside, Kevin Moran, Henry Siu, Andrea Tambalotti, Alex Wolman, and two referees for their comments and suggestions. We are also grateful for useful discussions with our colleagues and seminar participants at the 2009 Bank of Canada conference on New Frontiers in Monetary Policy Design, 2009 Bank of Canada/University of British Columbia workshop on Macroeconomics and Monetary Policy, at the 2nd Bank of Italy conference on Macro Modeling in the Policy Environment and at the 2009 Canadian Economic Association meetings. The views expressed are the authors’ and do not necessarily reflect those of the Bank of Canada or its staff.

Abstract

Quantitative dynamic stochastic general equilibrium (DSGE) models often admit that the zero bound on nominal interest rates does not constrain (optimal) monetary policy. Recent economic events, however, have reinforced the relevance of the zero bound. This paper sheds some light on this disconnect by studying a broad range of shocks within a standard DSGE model. In contrast to earlier studies, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. Other commonly included shocks, such as productivity, government spending, and money demand shocks, are unable to push nominal rates close to zero.

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