IDEAS home Printed from https://ideas.repec.org/p/fip/fedgfe/2014-105.html
   My bibliography  Save this paper

Conservatism and Liquidity Traps

Author

Listed:
  • Taisuke Nakata
  • Sebastian Schmidt

Abstract

Appointing Rogoff's (1985) conservative central banker improves welfare if the economy is subject to large contractionary shocks and the policy rate occasionally falls to the zero lower bound (ZLB). In an economy with occasionally binding ZLB constraints, the anticipation of future ZLB episodes creates a trade-off between inflation and output stabilization. As a consequence, inflation systematically falls below target even when the policy rate is above zero. A conservative central banker mitigates this deflationary bias away from the ZLB, improving allocations both at and away from the ZLB through expectations.

Suggested Citation

  • Taisuke Nakata & Sebastian Schmidt, 2014. "Conservatism and Liquidity Traps," Finance and Economics Discussion Series 2014-105, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2014-105
    as

    Download full text from publisher

    File URL: http://www.federalreserve.gov/econresdata/feds/2014/files/2014105pap.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    2. Adam, Klaus & Billi, Roberto M., 2006. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1877-1905, October.
    3. 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.
    4. Svensson, Lars E O, 1997. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts," American Economic Review, American Economic Association, vol. 87(1), pages 98-114, March.
    5. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    6. Anton Nakov, 2008. "Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate," International Journal of Central Banking, International Journal of Central Banking, vol. 4(2), pages 73-127, June.
    7. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    8. Niemann, Stefan, 2011. "Dynamic monetary–fiscal interactions and the role of monetary conservatism," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 234-247.
    9. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
    10. Taisuke Nakata, 2018. "Reputation and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 252-268, April.
    11. Nakata, Taisuke, 2016. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 220-240.
    12. Gauti Eggertsson & Bulat Gafarov & Saroj Bhatarai, 2014. "Time Consistency and the Duration of Government Debt: A Signalling Theory of Quantitative Easing," 2014 Meeting Papers 1292, Society for Economic Dynamics.
    13. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    14. R. Anton Braun & Lena Mareen Korber & Yuichiro Waki, 2013. "Small and orthodox fiscal multipliers at the zero lower bound," FRB Atlanta Working Paper 2013-13, Federal Reserve Bank of Atlanta.
    15. Adam, Klaus & Billi, Roberto M., 2008. "Monetary conservatism and fiscal policy," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1376-1388, November.
    16. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    17. Tambakis, Demosthenes N., 2014. "On the risk of long-run deflation," Economics Letters, Elsevier, vol. 122(2), pages 176-181.
    18. John C. Williams, 2016. "Monetary Policy in a Low R-star World," FRBSF Economic Letter, Federal Reserve Bank of San Francisco.
    19. Burgert, Matthias & Schmidt, Sebastian, 2014. "Dealing with a liquidity trap when government debt matters: Optimal time-consistent monetary and fiscal policy," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 282-299.
    20. Sebastian Schmidt, 2013. "Optimal Monetary and Fiscal Policy with a Zero Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(7), pages 1335-1350, October.
    21. Richter Alexander W. & Throckmorton Nathaniel A., 2015. "The zero lower bound: frequency, duration, and numerical convergence," The B.E. Journal of Macroeconomics, De Gruyter, vol. 15(1), pages 1-26, January.
    22. Billi, Roberto M., 2017. "A Note On Nominal Gdp Targeting And The Zero Lower Bound," Macroeconomic Dynamics, Cambridge University Press, vol. 21(8), pages 2138-2157, December.
    23. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    24. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 2019. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Credit and Capital Markets, Credit and Capital Markets, vol. 52(4), pages 537-571.
    25. Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-835, October.
    26. Sebastian Schmidt, 2017. "Fiscal Activism and the Zero Nominal Interest Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(4), pages 695-732, June.
    27. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    28. Roc Armenter, 2018. "The Perils of Nominal Targets," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 50-86.
    29. Guido Tabellini, 2014. "Inflation Targets Reconsidered: Comments on Paul Krugman," Working Papers 525, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    30. Adam, Klaus & Billi, Roberto M., 2014. "Distortionary fiscal policy and monetary policy goals," Economics Letters, Elsevier, vol. 122(1), pages 1-6.
    31. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
    32. Olivier Blanchard & Giovanni Dell’Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    33. Eggertsson, Gauti B., 2006. "The Deflation Bias and Committing to Being Irresponsible," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 283-321, March.
    34. Taisuke Nakata, 2018. "Reputation and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 252-268, April.
    35. Roc Armenter, 2013. "The perils of nominal targets," Working Papers 14-2, Federal Reserve Bank of Philadelphia.
    36. Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    37. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
    38. Mendes, Rhys R., 2011. "Uncertainty and the Zero Lower Bound: A Theoretical Analysis," MPRA Paper 59218, University Library of Munich, Germany.
    39. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-167, March.
    40. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172, National Bureau of Economic Research, Inc.
    41. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
    42. John C. Williams, 2014. "Inflation targeting and the global financial crisis: successes and challenges," Speech 134, Federal Reserve Bank of San Francisco.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Barthélemy, Jean & Mengus, Eric, 2018. "The signaling effect of raising inflation," Journal of Economic Theory, Elsevier, vol. 178(C), pages 488-516.
    2. Taisuke Nakata, 2017. "Uncertainty at the Zero Lower Bound," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(3), pages 186-221, July.
    3. Florin O. Bilbiie, 2019. "Optimal Forward Guidance," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(4), pages 310-345, October.
    4. Sebastian Schmidt, 2017. "Fiscal Activism and the Zero Nominal Interest Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(4), pages 695-732, June.
    5. Nakata, Taisuke, 2016. "Optimal fiscal and monetary policy with occasionally binding zero bound constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 220-240.
    6. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    7. Michau, Jean-Baptiste, 2019. "Monetary and fiscal policy in a liquidity trap with inflation persistence," Journal of Economic Dynamics and Control, Elsevier, vol. 100(C), pages 1-28.
    8. Jordi Galí, 2018. "The State of New Keynesian Economics: A Partial Assessment," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 87-112, Summer.
    9. Hills, Timothy S. & Nakata, Taisuke & Schmidt, Sebastian, 2019. "Effective lower bound risk," European Economic Review, Elsevier, vol. 120(C).
    10. Taisuke Nakata & Sebastian Schmidt, 2019. "Gradualism and Liquidity Traps," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 31, pages 182-199, January.
    11. Carl E. Walsh, 2011. "The Future of Inflation Targeting," The Economic Record, The Economic Society of Australia, vol. 87(s1), pages 23-36, September.
    12. Gavin, William T. & Keen, Benjamin D. & Richter, Alexander W. & Throckmorton, Nathaniel A., 2015. "The zero lower bound, the dual mandate, and unconventional dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 55(C), pages 14-38.
    13. Hasui, Kohei & Kobayashi, Teruyoshi & Sugo, Tomohiro, 2021. "Optimal irreversible monetary policy," European Economic Review, Elsevier, vol. 134(C).
    14. Hatcher, Michael & Minford, Patrick, 2014. "Stabilization policy, rational expectations and price-level versus infl‡ation targeting: a survey," CEPR Discussion Papers 9820, C.E.P.R. Discussion Papers.
    15. Binder, Michael & Lieberknecht, Philipp & Quintana, Jorge & Wieland, Volker, 2017. "Model Uncertainty in Macroeconomics: On the Implications of Financial Frictions," CEPR Discussion Papers 12013, C.E.P.R. Discussion Papers.
    16. Roberto M. Billi, 2011. "Optimal Inflation for the US Economy," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 29-52, July.
    17. Michael Hatcher & Patrick Minford, 2016. "Stabilisation Policy, Rational Expectations And Price-Level Versus Inflation Targeting: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 30(2), pages 327-355, April.
    18. Ngo, Phuong V., 2014. "Optimal discretionary monetary policy in a micro-founded model with a zero lower bound on nominal interest rate," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 44-65.
    19. Roulleau-Pasdeloup, Jordan, 2020. "Optimal monetary policy and determinacy under active/passive regimes," European Economic Review, Elsevier, vol. 130(C).
    20. Boneva, Lena & Harrison, Richard & Waldron, Matt, 2015. "Threshold-based forward guidance: hedging the zero bound," Bank of England working papers 561, Bank of England.

    More about this item

    Keywords

    Discretion; inflation conservatism; inflation targeting; liquidity traps; zero lower bound;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2014-105. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/frbgvus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (email available below). General contact details of provider: https://edirc.repec.org/data/frbgvus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.