Avoiding Liquidity Traps

Posted: 30 Jul 2002

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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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 since 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.

Suggested Citation

Benhabib, Jess and Schmitt-Grohe, Stephanie and Uribe, Martin, Avoiding Liquidity Traps. Journal of Political Economy, Vol. 110, June 2002, Available at SSRN: https://ssrn.com/abstract=309721

Jess Benhabib

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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Martin Uribe (Contact Author)

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

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