Avoiding Liquidity Traps

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 essent...

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Bibliographic Details
Published in:The Journal of political economy 2002-06, Vol.110 (3), p.535-563
Main Authors: Benhabib, Jess, Schmitt‐Grohé, Stephanie, Uribe, Martín
Format: Article
Language:English
Subjects:
Central banks
Economic growth rate
Economic models
Economic policy
Economic theory
Equilibrium
Federal Reserve monetary policy
Feedback
Fiscal policy
Inflation
Inflation rates
Interest rates
Liquidity
Liquidity trap
Macroeconomics
Monetary policy
Nominal interest rates
Policy making
Political economy
Prices
Taxes
Taylor rule
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Summary: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.
ISSN:0022-3808
1537-534X
DOI:10.1086/339713