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Escapist policy rules

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  • James B. Bullard
  • In-Koo Cho

Abstract

We study a simple, microfounded macroeconomic system in which the monetary authority employs a Taylor-type policy rule. We analyze situations in which the self-confirming equilibrium is unique and learnable according to Bullard and Mitra (2002). We explore the prospects for the use of ‘large deviation’ theory in this context, as employed by Sargent (1999) and Cho, Williams, and Sargent (2002). We show that our system can sometimes depart from the self-confirming equilibrium towards a non-equilibrium outcome characterized by persistently low nominal interest rates and persistently low in- flation. Thus we generate events that have some of the properties of “liquidity traps” observed in the data, even though the policymaker remains committed to a Taylor-type policy rule which otherwise has desirable stabilization properties.

Suggested Citation

  • James B. Bullard & In-Koo Cho, 2003. "Escapist policy rules," Working Papers 2002-002, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2002-002
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    References listed on IDEAS

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    Cited by:

    1. William Branch & George W. Evans, 2007. "Model Uncertainty and Endogenous Volatility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(2), pages 207-237, April.
    2. Iwamoto, Yasushi, 2005. "Monetary and Fiscal Policy to Escape from a Deflationary Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(1), pages 1-46, February.
    3. Kozicki, Sharon & Tinsley, P.A., 2005. "Permanent and transitory policy shocks in an empirical macro model with asymmetric information," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1985-2015, November.
    4. Evans, George W. & Guse, Eran & Honkapohja, Seppo, 2008. "Liquidity traps, learning and stagnation," European Economic Review, Elsevier, vol. 52(8), pages 1438-1463, November.
    5. Robert Tetlow & Peter von zur Muehlen, 2004. "Avoiding Nash Inflation: Bayesian and Robus Responses to Model Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 869-899, October.
    6. Stefano Eusepi, 2008. "Central bank transparency and nonlinear learning dynamics," Staff Reports 342, Federal Reserve Bank of New York.
    7. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
    8. James Bullard & Stefano Eusepi, 2005. "Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 324-359, April.
    9. Slobodyan, Sergey, 2005. "Indeterminacy, sunspots, and development traps," Journal of Economic Dynamics and Control, Elsevier, vol. 29(1-2), pages 159-185, January.
    10. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series,in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076 Central Bank of Chile.
    11. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
    12. Dmitri Kolyuzhnov & Anna Bogomolova, 2004. "Escape Dynamics: A Continuous Time Approximation," Econometric Society 2004 Latin American Meetings 27, Econometric Society.
    13. Kim, Young Se, 2009. "Exchange rates and fundamentals under adaptive learning," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 843-863, April.
    14. George W. Evans & Seppo Honkapohja, 2005. "Policy Interaction, Expectations and the Liquidity Trap," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 303-323, April.
    15. Martin Ellison & Liam Graham & Jouko Vilmunen, 2006. "Strong Contagion with Weak Spillovers," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 263-283, April.
    16. Benhabib, Jess & Evans, George W. & Honkapohja, Seppo, 2014. "Liquidity traps and expectation dynamics: Fiscal stimulus or fiscal austerity?," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 220-238.
    17. Kolyuzhnov, Dmitri & Bogomolova, Anna & Slobodyan, Sergey, 2014. "Escape dynamics: A continuous-time approximation," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 161-183.
    18. Bask, Mikael & Selander, Carina, 2007. "Robust Taylor rules in an open economy with heterogeneous expectations and least squares learnig," Research Discussion Papers 6/2007, Bank of Finland.
    19. Dmitri Kolyuzhnov & Anna Bogomolova, 2004. "Escape Dynamics: A Continuous Time Approximation," Econometric Society 2004 Far Eastern Meetings 557, Econometric Society.
    20. Waters, George A., 2009. "Learning, Commitment, And Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 13(04), pages 421-449, September.
    21. Selander, Carina, 2006. "Chartist Trading in Exchange Rate Theory," Umeå Economic Studies 698, Umeå University, Department of Economics.
    22. Waters, George A., 2007. "Regime changes, learning and monetary policy," Journal of Macroeconomics, Elsevier, vol. 29(2), pages 255-282, June.
    23. George W. Evans, 2008. "Monetary and Fiscal Policy under Learning in the Presence of a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 26, pages 59-86, December.
    24. Loisel, O., 2006. "Bubble-free interest-rate rules," Working papers 161, Banque de France.
    25. Dmitri Kolyuzhnov & Anna Bogomolova, 2004. "Escape Dynamics: A Continuous Time Approximation," Computing in Economics and Finance 2004 190, Society for Computational Economics.

    More about this item

    Keywords

    Monetary policy ; Inflation (Finance) ; Interest rates;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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