Efficient monetary policy design near price stability

Using dynamic programming methods, we study the design of optimal monetary policy in a simple, calibrated open-economy model and evaluate the effect o f the liquidity trap generated by the zero bound on nominal interest rates. We show that the optimal policy near price stability is asymmetric. As inf lation declines, policy turns expansionary sooner and more aggressively tha n would be optimal in the absence of the zero bound. This introduces an upw ard bias in the average level of inflation. We also discuss operational iss ues associated with the interpretation and implementation of policy at the zero bound in relation to the recent situation in Japan. (C) 2000 Academic Press Journal of Economic Literature Classification Numbers: E31, E52, E58, E61.