The Perils of Taylor Rules

30 Pages Posted: 20 Aug 1999

See all articles by Jess Benhabib

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 1999

Abstract

Since John Taylor's (1993) seminal paper, a large literature has argued that active interest rate feedback rules, that is, rules that respond to increases in inflation with a more than one-for-one increase in the nominal interest rate, are stabilizing. In this paper, we argue that once the zero bound on nominal interest rates is taken into account, active interest rate feedback rules can easily lead to unexpected consequences. Specifically, we show that even if the steady state at which monetary policy is active is locally the unique equilibrium, typically there exists an infinite number of equilibrium trajectories originating arbitrarily close to that steady state that converge to a liquidity trap, that is, a steady state in which the nominal interest rate is near zero and inflation is possibly negative.

JEL Classification: E52, E31, E63

Suggested Citation

Benhabib, Jess and Schmitt-Grohe, Stephanie and Uribe, Martin, The Perils of Taylor Rules (June 1999). Available at SSRN: https://ssrn.com/abstract=171749 or http://dx.doi.org/10.2139/ssrn.171749

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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Stephanie Schmitt-Grohe

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
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Martin Uribe (Contact Author)

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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United States

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