Avoiding Liquidity Traps
New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)
Duke University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)
Journal of Political Economy, Vol. 110, June 2002
Once the zero bound on nominal interest rates is taken into account, Taylor-type interest rate feedback rules give rise to unintended self-fulfilling decelerating inflation paths and aggregate fluctuations driven by arbitrary revisions in expectations. These undesirable equilibria exhibit the essential features of liquidity traps since monetary policy is ineffective in bringing about the government's goals regarding the stability of output and prices. This paper proposes several fiscal and monetary policies that preserve the appealing features of Taylor rules, such as local uniqueness of equilibrium near the inflation target, and at the same time rule out the deflationary expectations that can lead an economy into a liquidity trap.
Accepted Paper Series
Date posted: July 30, 2002
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