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

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  • Alstadheim Ragna

    ()
    (Norges Bank)

  • Henderson Dale W.

    ()
    (Federal Reserve Board)

Abstract

We study standard monetary-policy rules with inflation-rate targets and either interest-rate or money-supply instruments using a flexible-price, perfect-foresight model. We focus mainly on interest-rate rules, but the results for money-supply rules are analogous. A locally-unique target equilibrium always exists. There are also below-target equilibria (BTE) with inflation below target and constant or asymptotically approaching or eventually reaching a below-target value. Liquidity traps are neither necessary nor sufficient for BTE. Such equilibria can also arise if monetary policy keeps the interest rate above a lower bound. We construct monetary-policy rules that preclude BTE. All are non-monotonic and discontinuous in current inflation. Each implies a difference equation in inflation. Some of these difference equations are continuous, but others are not. They are all non-monotonic and non-differentiable at a point. We argue that Japan's difficulties in the 1990s were probably the result of a stabilization problem rather than an indeterminacy problem.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 6 (2006)
Issue (Month): 1 (November)
Pages: 1-27

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Handle: RePEc:bpj:bejmac:v:contributions.6:y:2006:i:1:n:12

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  1. Bennett T. McCallum, 2001. "Inflation Targeting and the Liquidity Trap," Working Papers Central Bank of Chile 112, Central Bank of Chile.
  2. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
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  8. Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February.
  9. Orphanides, Athanasios & Wieland, Volker, 2000. "Efficient Monetary Policy Design near Price Stability," Journal of the Japanese and International Economies, Elsevier, vol. 14(4), pages 327-365, December.
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  13. Evans, George W & Honkapohja, Seppo, 2003. "Policy Interaction, Expectation and Liquidity Trap," CEPR Discussion Papers 3925, C.E.P.R. Discussion Papers.
  14. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  15. Stephanie Schmitt-Grohe & Martin Uribe, 1997. "Price level determinacy and monetary policy under a balanced-budget requirement," Finance and Economics Discussion Series 1997-17, Board of Governors of the Federal Reserve System (U.S.).
  16. Evans , George W. & Honkapohja, Seppo, 2002. "Policy interaction, learning and the fiscal theory of prices," Research Discussion Papers 18/2002, Bank of Finland.
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  18. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
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Citations

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Cited by:
  1. Rym Aloui & Michel Guillard, 2009. "A Simple “Public Debt-Deflation” Theory: Leeper revisited," Documents de recherche 09-11, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
  2. Bennett T. McCallum, 2003. "Multiple-Solution Indeterminacies in Monetary Policy Analysis," NBER Working Papers 9837, National Bureau of Economic Research, Inc.
  3. Jean-Pascal Bénassy & Michel Guillard, 2005. "The Taylor Principle and Global Determinacy in a Non-Ricardian World," Documents de recherche 05-26, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
  4. Sugo, Tomohiro & Ueda, Kozo, 2008. "Eliminating a deflationary trap through superinertial interest rate rules," Economics Letters, Elsevier, vol. 100(1), pages 119-122, July.
  5. Bennett T. McCallum, 2002. "Consistent Expectations, Rational Expectations, Multiple-Solution Indeterminacies, and Least-Squares Learnability," NBER Working Papers 9218, National Bureau of Economic Research, Inc.
  6. Luis-Felipe Zanna & Marco Airaudo, 2012. "Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies," IMF Working Papers 12/121, International Monetary Fund.
  7. Airaudo, Marco & Zanna, Luis-Felipe, 2012. "Interest rate rules, endogenous cycles, and chaotic dynamics in open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 36(10), pages 1566-1584.
  8. Marco Airaudo & Luis-Felipe Zanna, 2005. "Interest rate rules, endogenous cycles, and chaotic dynamics in open economies," International Finance Discussion Papers 849, Board of Governors of the Federal Reserve System (U.S.).
  9. Jean-Pascal Bénassy & Michel Guillard, 2005. "The Taylor principle and global determinacy in a non Ricardian world," Working Papers halshs-00590558, HAL.
  10. Alexander W. Richter & Nathaniel A. Throckmorton, 2013. "The Zero Lower Bound: Frequency, Duration, and Determinacy," Auburn Economics Working Paper Series auwp2013-16, Department of Economics, Auburn University.

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