Conservatism and Liquidity Traps

46 Pages Posted: 9 Jan 2015

See all articles by Taisuke Nakata

Taisuke Nakata

Board of Governors of the Federal Reserve System

Sebastian Schmidt

European Central Bank (ECB)

Multiple version iconThere are 3 versions of this paper

Date Written: December 19, 2014

Abstract

Appointing Rogoff's (1985) conservative central banker improves welfare if the economy is subject to large contractionary shocks and the policy rate occasionally falls to the zero lower bound (ZLB). In an economy with occasionally binding ZLB constraints, the anticipation of future ZLB episodes creates a trade-off between inflation and output stabilization. As a consequence, inflation systematically falls below target even when the policy rate is above zero. A conservative central banker mitigates this deflationary bias away from the ZLB, improving allocations both at and away from the ZLB through expectations.

Keywords: Discretion, inflation conservatism, inflation targeting, liquidity traps, zero lower bound

JEL Classification: E52, E61

Suggested Citation

Nakata, Taisuke and Schmidt, Sebastian, Conservatism and Liquidity Traps (December 19, 2014). FEDS Working Paper No. 2014-105. Available at SSRN: https://ssrn.com/abstract=2544627 or http://dx.doi.org/10.2139/ssrn.2544627

Taisuke Nakata (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

Sebastian Schmidt

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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