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The pitfalls of speed-limit interest rate rules at the zero lower bound

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  • Brendon, Charles

    ()
    (European University Institute)

  • Paustian, Matthias

    ()
    (Bank of England)

  • Yates, Tony

    ()
    (Bank of England)

Abstract

We show that interest rate rules that feed back on the growth rates of target variables (such as output or asset prices) may induce recessions in the presence of a zero lower bound, through purely self-fulfilling dynamics. This pathology is illustrated in a small New Keynesian model with interest rates responding to the growth rate of output, and in a version of a model by Matteo Iacoviello where interest rates respond to the growth rate of house prices and credit. Our results provide a cautionary note, contrasting with previous work which has suggested several desirable properties of speed-limit rules, namely that they are devices enabling the policymaker (i) to side-step uncertainty about natural rates, (ii) to counter booms and busts in asset prices or (iii) to implement optimal commitment policies.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 473.

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Length: 35 pages
Date of creation: 14 Jun 2013
Date of revision:
Handle: RePEc:boe:boeewp:0473

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Keywords: Speed-limit rules; commitment; zero lower bound; self-fulfilling prophecies;

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  1. Mertens, Karel & Ravn, Morten O, 2011. "Credit Channels in a Liquidity Trap," CEPR Discussion Papers 8322, C.E.P.R. Discussion Papers.
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  9. Mehra, Yash P., 2002. "Level and growth policy rules and actual Fed policy since 1979," Journal of Economics and Business, Elsevier, vol. 54(6), pages 575-594.
  10. Nobuhiro Kiyotaki & Gauti Eggertsson & Andrea Ferrero & Marco Del Negro, 2010. "The Great Escape? A Quantitative Evaluation of the Fed’s Non-Standard Policies," 2010 Meeting Papers 113, Society for Economic Dynamics.
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  13. Blake, Andrew P., 2012. "Determining optimal monetary speed limits," Economics Letters, Elsevier, vol. 116(2), pages 269-271.
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