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Escapist policy rules

  • Bullard, James
  • Cho, In-Koo

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 inflation. 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.

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Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2003/38.

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Date of creation: 2003
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Handle: RePEc:zbw:cfswop:200338
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  1. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  2. 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.
  3. Cho, In-Koo & Sargent, Thomas J., 2000. "Escaping Nash inflation," Working Paper Series 0023, European Central Bank.
  4. Wieland, Volker, 2000. "Monetary policy, parameter uncertainty and optimal learning," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 199-228, August.
  5. George W. Evans & Seppo Honkapohja, 2004. "Policy interaction, expectations and the liquidity trap," Macroeconomics 0404033, EconWPA.
  6. William Poole & Robert H. Rasche, 2002. "Flation," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 1-6.
    • William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
  7. Woodford, Michael, 1990. "Learning to Believe in Sunspots," Econometrica, Econometric Society, vol. 58(2), pages 277-307, March.
  8. 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.
  9. Evans, George W. & Honkapohja, Seppo, 2003. "Policy interaction, expectation and the liquidity trap," Research Discussion Papers 22/2003, Bank of Finland.
  10. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  11. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  12. Wheelock,David C., 1991. "The Strategy and Consistency of Federal Reserve Monetary Policy, 1924–1933," Cambridge Books, Cambridge University Press, number 9780521391559, October.
  13. 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.
  14. Bennett T. McCallum, 2003. "Multiple-Solution Indeterminacies in Monetary Policy Analysis," NBER Working Papers 9837, National Bureau of Economic Research, Inc.
  15. 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.
  16. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  17. Timothy J. Kehoe & David K. Levine & Michael Woodford, 1990. "The optimum quantity of money revisited," Working Papers 404, Federal Reserve Bank of Minneapolis.
  18. Evans, George W. & Honkapohja, Seppo, 2003. "Policy Interaction, Expectation and Liquidity Trap," CEPR Discussion Papers 3925, C.E.P.R. Discussion Papers.
  19. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  20. Summers, Lawrence, 1991. "How Should Long-Term Monetary Policy Be Determined? Panel Discussion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 625-31, August.
  21. Woodford, Michael, 1990. "The optimum quantity of money," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 20, pages 1067-1152 Elsevier.
  22. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  23. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
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