In expectations-driven liquidity traps (LTs), a higher inflation target is associated with lower inflation and consumption. As a result, introducing the possibility of expectations-driven LTs to an otherwise standard model lowers the optimal inflation target. Using a calibrated New Keynesian model with an effective lower bound (ELB) constraint on nominal interest rates, we find that even a very small probability of falling into an expectations-driven LT lowers the optimal inflation target nontrivially. Our analysis provides a novel reason to be cautious about the argument that central banks should raise their inflation targets in light of a higher likelihood of hitting the ELB.

I evaluate differences in the response of the U.S. economy to productivity shocks around the effective lower bound (ELB) using post-WWII data. My empirical results indicate that positive productivity shocks are more expansionary when monetary policy operates away from the ELB, in line with a basic New Keynesian model, compared to the ELB regime. The interest-sensitive component of GDP, i.e., private investment, is the main driver of this nonlinear response. I find evidence of regime thresholds beyond the standard 0.25% Federal Funds Rate definition of the ELB that could influence the state-dependent shock response of the economy. My work highlights the role played by the monetary policy channel in changing the propagation of productivity shocks to the U.S. economy.

This paper constructs a two-period general equilibrium model with the effective lower bound of nominal interest rates and describes price competition among monopolistically competitive firms as a coordination game. While the model has multiple equilibria with different levels of inflation (positive or zero), the equilibrium selection in line with global games implies that the economy with high expected productivity growth moves into the positive inflation equilibrium. The policy analyses indicate that monetary policy measures such as an increase in the target inflation can prevent the economy from moving into the zero inflation equilibrium even with low productivity growth.

We estimate the effects of government spending shocks during prolonged episodes of low interest rates, which we consider as proxy for the effective lower bound (ELB). Using a panel VAR model for 17 advanced countries, we find that both the government consumption and investment multipliers are significantly higher, and exceed unity, when interest rates are persistently low. Distinguishing between construction- and equipment-related government investments, we find that only the former raises output by significantly more when the ELB binds. This result can be explained by existing New Keynesian models featuring time-to-build constraints on government investment.

This paper provides estimates of the probability of an economy hitting its effective lower bound (ELB) on the nominal interest rate and of the expected duration of such an event for eight advanced economies. To that end, a mean-adjusted panel vector autoregression with static interdependencies and the possibility of regime change is estimated. The simulation procedure produces ELB risk estimates for both the short term, where the current phase of the business cycle plays an important role, and the medium term, where the occurrence of an ELB situation is determined mainly by the equilibrium values of macroeconomic variables. The paper also discusses the ELB event probability estimates with respect to previous approaches used in the literature.