Notes on "Method of Policy Accommodation at the interest-rate lower Bound" by Michael Woodford

Method of Policy Accommodation at the interest-rate lower Bound

Michael Woodford, Columbia University

September 16,2012

• other option for policy accommodation exist, apart from additional cuts in the current level of overnight interest rates:
• forward guidance 
• balance-sheet policies:  CB (central bank) varies either the size or the composition of its balance sheet
• people's expectations about future policy are critical aspect of the way in which monetary policy decisions affect the economy

• zero lower bound 
• whether market expectation of the forward path of the US federal funds rate seem to change over a narrow time window around the release of a post- meeting statement by the Federal Open Market Committee.

• real life example result the Bank of Canada's statement in 2009:
• implies either that expectations of policy rates for months in early 2010 fall even more than do nearer-term expectations, or that uncertainty  about the path of the policy rate over the coming year has been substantially reduced.
• forward guidance outside the context of routine predictions about the future path of interest rates is more often interpreted as revealing central-bank policy intentions.

 

• accompany any discussion of the forward path of interest rates with an explanation of the considerations behind it.

 

• Expanding the Supply of Bank Reserves
• the use of changes in the central bank's balance sheet- its overall size, the composition of its assets, and the share of its liabilities that are " monetary" in character - as additional dimensions of policy, apart from the central bank's influence over oversight money- market rates.  =>QE.
• the increase in broad money necessarily increase aggregate nominal expenditure, in proportion to the increase in money if the " velocity of money " remains stable.

• the model of Auerbach and Obstfeld assumes a cash-in-advance constraint, as a result of which the demand for base money is equal to aggregate nominal expenditure each period, except when the nominal interest rate falls to zero. Hence the commitment of a deterministic path for the monetary base is equivalent to a commitment to a deterministic target path for aggregate nominal expenditure together with a commitment to use monetary policy to keep nominal expenditure equal to the target at all times, unless expenditure undershoots the target even when the money supply is already large enough to drive the nominal interest rate at zero. 

• The demonstration by Auerbach and Obstfeld that welfare can be increased by permanently increasing the supply of base money could alternatively be used to show that welfare could be inseased by committing to keep the nominal interest rate at zero until it is possible to hit a certain deterministic target path for nominal GDP, and then use monetary policy to keep nominal GDP growing at a steady rate thereafter. The inferior initial equilibrium is instead one in which nominal GDP is allowed to follow a permanently lower path,  albeit with the same long-run growth rate.