Inflation Targeting and the Liquidity Trap

54 Pages Posted: 8 Apr 2001 Last revised: 21 Oct 2010

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Date Written: April 2001

Abstract

This paper considers whether 'liquidity trap' issues have important bearing on the desirability of inflation targeting as a strategy for monetary policy. From a theoretical perspective, it has been suggested that 'expectation trap' and 'indeterminacy' dangers are created by variants of inflation targeting, the latter when forecasts of future inflation enter the policy rule. This paper argues that these alleged dangers are probably not of practical importance. From an empirical perspective, a quantitative open-economy model is developed and the likelihood of encountering a liquidity trap is explored for several policy rules. Also, it is emphasized that, if the usual interest rate instrument is immobilized by a liquidity trap, there is still an exchange-rate channel by means of which monetary policy can exert stabilizing effects. The relevant target variable can still be the inflation rate.

Suggested Citation

McCallum, Bennett T., Inflation Targeting and the Liquidity Trap (April 2001). NBER Working Paper No. w8225. Available at SSRN: https://ssrn.com/abstract=266195

Bennett T. McCallum (Contact Author)

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