Some changes to the inflation-targeting policy framework are, however, likely to be considered once Mark Carney succeeds Mervyn King as governor in July, since the Canadian appears to hold a more optimistic view than Mr King that there is more that monetary policy can do to stimulate the economy at the "zero lower bound" (when nominal policy rates are close to 0%).
They facilitate adjustment amid nominal rigidities, the most important of which is the inability of the central bank's policy rate to fall below zero: higher inflation means a more negative, and more stimulative, real interest rate.
As Ellingsen and Söderström (2001) discuss, long-run nominal rates reflect expected policy rates, term premia and inflation expectations.
Based on the estimated autoregressive distributed lag (ARDL), fully-modified ordinary least squares, and dynamic ordinary least squares models, the nominal exchange and monetary policy rates are shown tohave significant contemporaneous effects on the lending interest rate.
While policy rates are sharply falling, the nominal and real rates faced by households are rising rather than falling: rising mortgage rates, rising rates on credit cards, auto loans and student loans, together with less availability of credit are severely dampening the ability of households to borrow and spend.
This generates steady-state predictions for policy rates, as credible inflation targets should be associated with an appropriate long-run nominal interest rate.
Santaella and Vela (2005) provide an excellent description and analysis of nominal exchange rate policy in Mexico during the tumultuous period of 1987–1994.
When further interest rate cuts are desired but prevented by the zero lower bound on nominal interest rates, policy switches to balance sheet measures.Three-quarter ahead forecasts from 2012 Q2 to 2014:Q4 are derived from the January 25 , 2012FOMC forecasts for 2012, 2013 and 2014 shown in Table 1.
Since the incentives to the ECB are to buy credibility through a disciplined monetary policy, nominal interest rates are probably being kept high.
