The Zero Bound and the Term Structure in a Nonlinear Macroeconomic Model

Abstract

The zero bound on nominal interest rates inherently imposes a nonlinearity on models in which money is nonneutral. However, for simplicity, analyses of the zero bound have typically been conducted in models which are otherwise linear. In a nonlinear staggered price-setting model, we examine how the zero bound makes the term structure of interest rates and macroeconomic dynamics sensitive to the economy's average inflation rate. We decompose this sensitivity into two components: (i) A pure expectations component, associated with the fact that the average inflation rate and the zero bound interact to affect the expected future path of short rates; and (ii) a term premium component, associated with the fact that the aforementioned interaction alters the behavior of the term premium. The first component is present in analyses where the zero bound is the only nonlinearity; the second component is absent in those analyses.