A Discrete Monetary Policy Framework An Application to the Japanese Economy

Since Taylor (1993), monetary policy is usually modeled through continuous contingent rules. In this paper, we propose an original alternative discrete modeling of the monetary policy reaction function. While this modeling covers a wide range of problems, we provide a simple application to the particularly topical issue of the Zero Lower Bound. First, we give exact determinacy conditions for a broad class of general equilibrium models with rational expectations in which monetary policy follows a discrete rule. More precisely, at each period, the central bank changes its interest rate with a probability linearly depending on the economic conditions. This hypothesis seems more empirically relevant as central bank overwhelmingly raises or decreases its interest rates by a fixed step namely 25bps. Then, we give a closed-form solution and document the difference with standard Taylor rules. Finally, we give some illustrations of the method in developing a standard New Keynesian model with discrete monetary policy which formally allows for Zero Lower Bound. We calibrate and confront it to the Japanese economy since 1996.