Liquidity Traps with Global Taylor Rules

27 Pages Posted: 2 Oct 2001

See all articles by Stephanie Schmitt-Grohé

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

A key result of a recent literature that focuses on the global consequences of Taylor-type interest rate feedback rules is that such rules, in combination with the zero-bound on nominal interest rates, can lead to unintended liquidity traps. An immediate question posed by this result is whether the government could avoid liquidity traps by ignoring the zero-bound, that is, by threatening to set the nominal interest rate at a negative value should the inflation rate fall below a certain threshold. This Paper shows that even if the government could credibly commit to setting the interest rate at a negative value, self-fulfilling liquidity traps can still emerge. That is, deflationary equilibria originating arbitrarily near the intended equilibrium and leading to low (possibly zero) interest rates and low (and possibly negative) rates of inflation cannot be ruled out by lifting the zero-bound on the monetary policy rule. This result obtains in models with flexible and sticky prices and under continuous and discrete time.

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

JEL Classification: E31, E52, E63

Suggested Citation

Schmitt-Grohe, Stephanie and Uribe, Martin, Liquidity Traps with Global Taylor Rules (September 2001). Available at SSRN: https://ssrn.com/abstract=285945

Stephanie Schmitt-Grohe (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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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National Bureau of Economic Research (NBER)

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