In Search for Appropriate Lower Bound. Zero Lower Bound vs. Positive Lower Bound Under Discretion and Commitment

We lay a ground for a simple comparison of positive and possible side (adverse) effects of zero interest rate policy (ZLB policy) on welfare. Using a standard New Keynesian dynamic stochastic general equilibrium model, we show that if one assumes that the ZLB policy has no side effects, then this policy is welfare enhancing relative to positive lower bound (PLB) policy, except for the case where PLB policy is pursued under commitment, while the ZLB policy is discretionary. However, moderate side effects of the ZLB policy usually suffice for the PLB policy to pay off in terms of welfare. Only if the ZLB policy was pursued under commitment, while PLB policy was discretionary, would the PLB policy dominance over the ZLB policy, in terms of welfare, require strong side effects of ZLB policy. Otherwise PLB policy could dominate the ZLB policy in terms of welfare, even if restructuring, fostered by the PLB policy, entailed some costs, which could be reduced (or avoided) through slow restructuring. For given side effects of the ZLB, the larger and the more persistent the shock that makes the ZLB bind, the more likely PLB policy dominance over the ZLB policy. The findings holds for economies with both fast and slow potential output growth, with low and high inflation target, flexible and rigid