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Misconceptions Regarding the Zero Lower Bound on Interest Rates

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  • Bennett T. McCallum

    (Carnegie Mellon University (E-mail: bmccallum@cmu.edu))

Abstract

The paper reviews issues related to the zero lower bound (ZLB) on interest rates and argues that all of the following propositions are invalid: (1) in a ZLB situation, gshaping interest rate expectations is essentially the only tool that central bankers haveh (Bernanke, Reinhart, and Sack [2004]); (2) fiscal policy actions such as ghelicopter dropsh are in theory more effective than monetary policy actions; (3) the prominent gfoolproof wayh policy rule of Svensson (2001, 2003) is applicable more generally?that is, even when exact uncovered interest parity holds?than the alternative exchange rate rule of McCallum (2000); (4) both of the exchange rate strategies described in (3) are open to the objection that they constitute gbeggar-thy-neighborh approaches; and (5) there is a significant danger of ZLB difficulties stemming from a g deflationary traph type of equilibrium, as distinct from a gliquidity trap.h

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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 24 (2006)
Issue (Month): S1 (December)
Pages: 13-26

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Handle: RePEc:ime:imemes:v:24:y:december:i:s1:p:13-26

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Keywords: Interest rates; Zero lower bound; Quantitative easing; Expectations; Deflation trap; Liquidity trap;

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