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Liquidity Traps with Global Taylor Rules

Listed author(s):
  • Stephanie Schmitt-Grohe

    ()

    (Rutgers University)

  • Martin Uribe

    ()

    (University of Pennsylvania)

A key result of a recent literature that focuses on the global consequences of Taylor-type interest rate feedback rules is that such rules in combination with the zero bound on nominal interest rates can lead to unintended liquidity traps. An immediate question posed by this result is whether the government could avoid liquidity traps by ignoring the zero bound, that is, by threatening to set the nominal interest rate at a negative value should the inflation rate fall below a certain threshold. This paper shows that even if the government could credibly commit to setting the interest rate at a negative value, self-fulfilling liquidity traps can still emerge. That is, deflationary equilibria originating arbitrarily near the intended equilibrium and leading to low (possibly zero) interest rates and low (and possibly negative) rates of inflation cannot be ruled out by lifting the zero bound on the monetary policy rule. This result obtains in models with flexible and sticky prices and under continuous and discrete time.

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File URL: http://www.sas.rutgers.edu/virtual/snde/wp/2000-14.pdf
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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 200014.

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Date of creation: 25 Jul 2000
Handle: RePEc:rut:rutres:200014
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  1. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
  2. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "Monetary policy and multiple equilibria," Finance and Economics Discussion Series 1998-29, Board of Governors of the Federal Reserve System (U.S.).
  3. Buiter, Willem H., 1998. "The Young Person's Guide to Neutrality, Price Level Indeterminacy, Interest Rate Pegs and Fiscal Theories of the Price Level," CEPR Discussion Papers 1799, C.E.P.R. Discussion Papers.
  4. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
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  7. Bill Dupor, 2000. "Investment and Interest Rate Policy," Econometric Society World Congress 2000 Contributed Papers 0007, Econometric Society.
  8. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers 199925, Rutgers University, Department of Economics.
  9. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "The perils of Taylor Rules," Departmental Working Papers 199831, Rutgers University, Department of Economics.
  10. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  11. Robert E. Lucas Jr. & Nancy L. Stokey, 1984. "Money and Interest in Cash-In-Advance Economy," Discussion Papers 628, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  12. Willem H. Buiter, 1999. "The Fallacy of the Fiscal Theory of the Price Level," NBER Working Papers 7302, National Bureau of Economic Research, Inc.
  13. Schmitt-Grohe, Stephanie & Uribe, Martin, 2000. "Price level determinacy and monetary policy under a balanced-budget requirement," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 211-246, February.
  14. Andrew T. Levin & Volker W. Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series 1998-45, Board of Governors of the Federal Reserve System (U.S.).
  15. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  16. Brian P. Sack, 1998. "Uncertainty, learning, and gradual monetary policy," Finance and Economics Discussion Series 1998-34, Board of Governors of the Federal Reserve System (U.S.).
  17. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  18. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  19. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  20. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
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