The pitfalls of speed-limit interest rate rules at the zero lower bound

Charles Brendon (), Matthias Paustian () and Anthony Yates ()
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Charles Brendon: European University Institute
Matthias Paustian: Bank of England, Postal: Publications Group Bank of England Threadneedle Street London EC2R 8AH

No 473, Bank of England working papers from Bank of England

Abstract: We show that interest rate rules that feed back on the growth rates of target variables (such as output or asset prices) may induce recessions in the presence of a zero lower bound, through purely self-fulfilling dynamics. This pathology is illustrated in a small New Keynesian model with interest rates responding to the growth rate of output, and in a version of a model by Matteo Iacoviello where interest rates respond to the growth rate of house prices and credit. Our results provide a cautionary note, contrasting with previous work which has suggested several desirable properties of speed-limit rules, namely that they are devices enabling the policymaker (i) to side-step uncertainty about natural rates, (ii) to counter booms and busts in asset prices or (iii) to implement optimal commitment policies.

Keywords: Speed-limit rules; commitment; zero lower bound; self-fulfilling prophecies (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2013-06-14
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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