Price-Level Determinancy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps

36 Pages Posted: 8 May 2004

See all articles by Dale W. Henderson

Dale W. Henderson

Federal Reserve Board

Ragna Alstadheim

Howard University - Department of Economics

Date Written: April 2004

Abstract

We consider monetary-policy rules with inflation-rate targets and interest-rate or money-growth instruments using a flexible-price, perfect-foresight model. There is always a locally-unique target equilibrium. There may also be below-target equilibria (BTE) with inflation always below target and constant, asymptotically approaching or eventually reaching a below-target value, or oscillating. Liquidity traps are neither necessary nor sufficient for BTE which can arise if monetary policy keeps the interest rate above a lower bound. We construct monetary rules that preclude BTE when fiscal policy does not. Plausible fiscal policies preclude BTE for any monetary policy; those policies exclude surpluses and, possibly, balanced budgets.

Keywords: Price-level indeterminacy, multiple equilibria, zero bound, monetary policy, monetary rule, fiscal policy, money demand

JEL Classification: E31, E50, E62, E41

Suggested Citation

Henderson, Dale W. and Alstadheim, Ragna, Price-Level Determinancy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps (April 2004). Available at SSRN: https://ssrn.com/abstract=541342 or http://dx.doi.org/10.2139/ssrn.541342

Dale W. Henderson (Contact Author)

Federal Reserve Board ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2343 (Phone)
202-736-5638 (Fax)

Ragna Alstadheim

Howard University - Department of Economics ( email )

Washington, DC 20059
United States

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