AUTHOR: Siddhartha Chattopadhyay, Taniya Ghosh
TITLE: Taylor Rule Implementation of the Optimal Policy at the Zero Lower Bound: Does the Cost Channel Matter?
This paper analyzes the implementation of the optimal policies at the Zero Lower Bound (ZLB) by the Taylor rule in the presence of cost channel. We find that, the presence of cost channel significantly impairs the ability of the Taylor rule to implement optimal policies when economy is subject to the ZLB. The main findings of the paper are, (i) the Taylor rule with optimally chosen inflation target partially implements the optimal discretionary policy but cannot implement the optimal policy under commitment, and (ii) the T-only policy, which follows discretion after an optimally chosen exit date from the ZLB, is the best that can be implemented by the Taylor rule in the presence of cost channel.
Keywords: New-Keynesian Model, Cost Channel, ZLB
JEL Code: E63, E52, E58