Reputation and Liquidity Traps

63 Pages Posted: 30 Jul 2014

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: June 30, 2014

Abstract

Can the central bank credibly commit to keeping the nominal interest rate low for an extended period of time in the aftermath of a deep recession? By analyzing credible plans in a sticky-price economy with occasionally binding zero lower bound constraints, I find that the answer is yes if contractionary shocks hit the economy with sufficient frequency. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, keeping the central bank on the originally announced path of low nominal interest rates.

Keywords: credible policy, forward guidance, reputation, sustainable plan, time consistency, trigger strategy, zero lower bound

JEL Classification: E32, E52, E61, E62, E63

Suggested Citation

Nakata, Taisuke, Reputation and Liquidity Traps (June 30, 2014). FEDS Working Paper No. 2014-50. Available at SSRN: https://ssrn.com/abstract=2473075 or http://dx.doi.org/10.2139/ssrn.2473075

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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