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Avoiding Liquidity Traps

  • Jess Benhabib

    ()

    (New York University)

  • Stephanie Schmitt-Grohe

    ()

    (Rutgers University)

  • Martin Uribe

    ()

    (University of Pennsylvania)

Once the zero bound on nominal interest rates is taken into account, Taylor-type interest-rate feedback rules give rise to unintended self-fulfilling decelerating inflation paths and aggregate fluctuations driven by arbitrary revisions in expectations. These undesirable equilibria exhibit the essential features of liquidity traps, as monetary policy is ineffective in bringing about the government's goals regarding the stability of output and prices. This paper proposes several fiscal and monetary policies that preserve the appealing features of Taylor rules, such as local uniqueness of equilibrium near the inflation target, and at the same time rule out the deflationary expectations that can lead an economy into a liquidity trap.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 199925.

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Date of creation: 30 Apr 2000
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Handle: RePEc:rut:rutres:199925
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  28. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
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