NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Endogenous Volatility at the Zero Lower Bound: Implications for Stabilization Policy

Susanto Basu, Brent Bundick

NBER Working Paper No. 21838
Issued in December 2015
NBER Program(s):Economic Fluctuations and Growth, Monetary Economics

At the zero lower bound, the central bank's inability to offset shocks endogenously generates volatility. In this setting, an increase in uncertainty about future shocks causes significant contractions in the economy and may lead to non-existence of an equilibrium. The form of the monetary policy rule is crucial for avoiding catastrophic outcomes. State-contingent optimal monetary and fiscal policies can attenuate this endogenous volatility by stabilizing the distribution of future outcomes. Fluctuations in uncertainty and the zero lower bound help our model match the unconditional and stochastic volatility in the recent macroeconomic data.

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Document Object Identifier (DOI): 10.3386/w21838

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