On zero lower bound trapsa framework for the analysis of monetary policy in the "age" of central banks

Resumen

Conventional explanations of how a growing potential output generates an equi-proportional increase in aggregate demand in the long run rely either on the operation of the real balance effect or on a combination of the permanent income hypothesis and the assumption of individuals´ perfect foresight. We argue that these two mechanisms are grossly unrealistic and that the bulk of the adjustment process occurs through the impact of conventional monetary policy actions. As a result of it, the main constraint this mechanism is subject to takes the form of a zero lower bound on short-term nominal interest rates. We develop a general framework based on a small model for a closed economy without government sector in which a central bank attempts to hit an inflation target and obtain a number of results.