How does the ZLB affect the properties of alternative exchange rate systems?

Abstract

We use a standard, two-country Dynamic Stochastic General Equilibrium (DSGE) model with multiple shocks and a Taylor rule to study the effects of the Zero Lower Bound (ZLB) under alternative international monetary arrangements. Whether the ZLB constraint plays a stabilizing or destabilizing role depends on the exchange rate regime and the type of shock. Different shocks may favor different regimes, and the ZLB may lead to a reversal of the ranking of the regimes for some shocks, especially domestic ones. Notwithstanding such individual shock reversals, when considering the groups of external or domestic shocks or all shocks together in a typical economy that stochastically alternates between the ZLB and the non-ZLB states, we find that the introduction of a ZLB constraint does not by itself suffice to make policymakers rethink their choice of the exchange rate regime.