Download This PaperAvoiding Liquidity Traps
32 Pages Posted: 12 Jan 2000
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Avoiding Liquidity Traps
Date Written: December 1999
Abstract
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, as 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.
JEL Classification: E52, E31, E63
Suggested Citation: Suggested Citation
Jess Benhabib
New York University - Leonard N. Stern School of Business - Department of Economics ( email )
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