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

Author

Listed:
  • 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.

Suggested Citation

  • Brendon, Charles & Paustian, Matthias & Yates, Tony, 2013. "The pitfalls of speed-limit interest rate rules at the zero lower bound," Bank of England working papers 473, Bank of England.
  • Handle: RePEc:boe:boeewp:0473
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2013/the-pitfalls-of-speed-limit-interest-rate-rules-at-the-zero-lower-bound.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Holden, Thomas, 2016. "Existence and uniqueness of solutions to dynamic models with occasionally binding constraints," EconStor Preprints 130142, ZBW - German National Library of Economics.

    More about this item

    Keywords

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

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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