Staggered price setting and the zero bound on the nominal interest rates

T he nominal interest rate cannot be less than zero: no one would chooseto hold assets bearing a guaranteed negative nominal return when theycould instead hold money, which bears a guaranteed zero nominal re-turn. Does the zero bound have normative implications for monetary policy? The nominal interest rate tends to be low when expected inflation is low, so the lower expected inflation is, the more likely it is that zero nominal interest rates would be encountered. Some have argued that the zero bound’s proximity at low inflation constitutes an argument against policy that results in low inflation or deflation.1 Here we compare moderately deflationary and moderately infla-tionary regimes using a macroeconomic model to evaluate whether the zero bound introduces distortions that make low inflation undesirable. The model and the method distinguish our analysis from other recent re-search on the same topic.2 The model has optimizing behavior by individuals and firms, with the qualification that firms ’ price setting is staggered. Other analyses of the zero bound have also used sticky-price models; the zero bound is more likely to be important if nominal disturbances have real effects, as they do with sticky prices. Individuals in the model choose to hold money because it decreases the time they must spend shopping. Other analyses have not modeled money demand. The method we employ involves solving the entire model nonlinearly, which means directly imposing the zero bound on nomina