Explain the Zero Lower Bound (ZLB) and its implications for monetary policy when there is deflation. Assume expected inflation is -2% and the desired real interest rate is 2%. Calculate the nominal po

Question 3:

The zero lower bound (ZLB) means the nominal policy interest rate cannot go below $0\%$. The real interest rate is approximately the nominal interest rate minus expected inflation ($r \approx i - \pi^e$).

• a), b), c), d): If expected inflation is negative (deflation), the central bank might need to set the nominal rate to $0\%$ to achieve a desired real interest rate.
  • Let's assume expected inflation (a) is $-2\%$.
  • If the desired real interest rate (b) is $2\%$.
  • Then, to achieve this, the nominal policy interest rate should be