02 - On the Emergence of a Binding Zero Lower Bound

Wetenschappelijke publicatie
Date 18 March 2004

Overoptimism regarding productivity developments is often seen as the root of the worldwide cyclical downturn at the beginning of the 21st century. This paper develops a New Keynesian model with credit market imperfections that shows how overly positive productivity expectations initially drive the interest rate risk premium below its equilibrium value, boosting real economic growth. When a downward correction of the outlook appears inevitable, collateral value shrinks and the interest rate risk premium rises sharply. Given this risk premium, a substantially lower (risk free) policy rate is required in order to reduce market rates. In such a situation a binding zero lower bound can emerge. JEL codes: E31, E32, E52 Key words: zero lower bound, financial accelerator, technology shocks