02 - On the Emergence of a Binding Zero Lower Bound

Wetenschappelijke publicatie
Publicatiedatum 18 maart 2004

Abstract: 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