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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 19, No. 1, pp.147-170
ISSN: 1225-0279 (Print)
Print publication date 28 Feb 2006
Received 17 Sep 2005 Revised 10 Nov 2005

The Zero Bound and the Term Structure in a Nonlinear Macroeconomic Model

Alexander L. Wolman
Senior Economist, Research Department, Federal Reserve Bank of Richmond, P.O. Box 27622, Richmond, VA 23261, U.S.A., Tel: +1-804- 697-8262, Fax: +1-804-697-8217 alexander.wolman@rich.frb.org

JEL Classfication: E31, E43, G12

Abstract

The zero bound on nominal interest rates inherently imposes a nonlinearity on models in which money is nonneutral. However, for simplicity, analyses of the zero bound have typically been conducted in models which are otherwise linear. In a nonlinear staggered price-setting model. we examine how the zero bound makes the term structure of interest rates and macroeconomic dynamics sensitive to the economy's average inflation rate. We decompose this sensitivity into two components: (i) A pure expectations component, associated with the fact that the average inflation rate and the zero bound interact to affect the expected future path of short rates; and (ii) a term premium component, associated with the fact that the aforementioned interaction alters the behavior of the term premium. The first component is present in analyses where the zero bound is the only nonlinearity; the second component is absent in those analyses.

Keywords:

Zero bound, Term structure, Sticky prices

Acknowledgments

For helpful comments the author thanks Young Sik Kim, who discussed the paper at the 13th Seoul Journal of Economics International Symposium, September 23, 2005 at Seoul National University. The views in this paper are those of the author and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

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