Avoiding Liquidity Traps

44 Pages Posted: 20 Sep 2001

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)

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Date Written: September 2001

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.

Keywords: Taylor rules, liquidity traps, zero-bound on nominal interest rates

JEL Classification: E31, E52, E63

Suggested Citation

Benhabib, Jess and Schmitt-Grohe, Stephanie and Uribe, Martin, Avoiding Liquidity Traps (September 2001). Available at SSRN: https://ssrn.com/abstract=283696

Jess Benhabib (Contact Author)

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 )

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National Bureau of Economic Research (NBER)

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Martin Uribe

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

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