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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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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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  • 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.


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  • 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.


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Canada and Japan term structure dynamics in Canada.

  • 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.


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  • Consider a Taylor rule: term structure dynamics in Canada.

    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.


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


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  • The Bank of Japan’s choice of http://research.stlouisfed.org/publications/IETsupplement/iet2inf.pdfΠ* = 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.


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Persistence in the Short-Term Rate strategy.

  • 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.


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Adding More Structure to the Model avoiding the ZLB?

  • 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.


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  • 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.


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The Benefits of Inflation Targeting short-term rates using a Taylor rule instead of a pure time series model …

  • 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.


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  • Providing more explicit information about short-term rates using a Taylor rule instead of a pure time series model …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.