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Comments on Francisco J. Ruge-Murcia’s “The Zero Lower Bound on Interest Rates and Monetary Policy in Canada” PowerPoint Presentation
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Comments on Francisco J. Ruge-Murcia’s “The Zero Lower Bound on Interest Rates and Monetary Policy in Canada” Bank of Canada Economic Conference “Issues in Inflation Targeting” April 28-29, 2005 Peter N. Ireland Boston College and NBER

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slide1

Comments on Francisco J. Ruge-Murcia’s“The Zero Lower Bound on Interest Rates and Monetary Policy in Canada”

Bank of Canada Economic Conference

“Issues in Inflation Targeting”

April 28-29, 2005

Peter N. Ireland

Boston College and NBER

slide2
This paper skillfully constructs, estimates, and analyzes a model of the term structure of interest rates that explicitly accounts for the zero lower bound (ZLB) on the short-term rate.
  • The intuition: Use longer-term rates to draw inferences about the likelihood that the short-term interest rate will bump up against the ZLB at some point in the future.
slide3
The result: The ZLB has not played a big role in shaping term structure dynamics in Canada.
  • Implication for term-structure modelers: Linear models that abstract from the ZLB suffice for describing the Canadian data.
  • Implication for monetary policymakers: Good news for the Bank of Canada …
  • … and possibly for other inflation-targeting central banks as well.
canada and japan
Canada and Japan
  • A companion paper, Ruge-Murcia (2002), finds that the ZLB has mattered for the term structure in Japan.
  • The comparison between Canada and Japan highlights a number of more general issues.
slide5
Consider a Taylor rule:

R = R* + a(Y−Y*) + b(Π−Π*)

  • There is a trade-off in setting the inflation target Π*:
  • Setting Π* too high imposes welfare costs of inflation …
  • … but setting Π* too low risks bumping up against the ZLB.
slide6

Source: http://research.stlouisfed.org/publications/IETsupplement/iet2inf.pdf

slide7
The Bank of Japan’s choice of Π* = 0 is probably too low
  • … but the Bank of Canada’s choice of Π* = 2 seems about right.
  • Hence, it appears that the trade-off involved in choosing Π* can be managed satisfactorily.
slide8
Also, Japan has not adopted an official inflation targeting strategy.
  • Does inflation targeting reduce the problems associated with the ZLB?
  • It would be useful to extend the analysis to a larger sample of countries to find out.
persistence in the short term rate
Persistence in the Short-Term Rate
  • For Canada:

rstart = 0.977rt-1− 0.053rt-2 + 0.074rt-3

  • For Japan:

rstart = 0.598rt-1+ 0.127rt-2 + 0.214rt-3

  • Largest root: 0.9982 for Canada and 0.9615 for Japan.
slide10
What role does persistence in the short-term rate play in avoiding the ZLB?
  • Adding persistence seems to have been the preferred solution in the US.
adding more structure to the model
Adding More Structure to the Model
  • An important intermediate result: the volatility, as well as the level, of the short-term interest rate matters.
  • But, from a central banker’s perspective, the level and volatility of the short-term rate can both be influenced by policy.
slide12
Elaborating on the model by describing the dynamics of short-term rates using a Taylor rule instead of a pure time series model …
  • … and by thinking hard about the fundamental sources of volatility in short-term rates …
  • … would be quite useful in teasing out additional policy implications.
the benefits of inflation targeting
The Benefits of Inflation Targeting
  • When adopting the Taylor rule

R = R* + a(Y−Y*) + b(Π−Π*)

the central bank chooses Π* as well as a and b.

  • Every central bank has an inflation target!
  • The only question is whether and how to communicate information about Π* to the public.
slide14
Providing more explicit information about Π* can potentially help …
  • ... partly by minimizing the problem of inflation scares (keeping interest rates low) …
  • … but perhaps also by minimizing the problems associated with the ZLB (but not too low).
  • Francisco’s paper contributes importantly to the debate by highlighting the second set of issues.