Price-Level Determinacy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps

Ragna Alstadheim () and Dale Henderson

The B.E. Journal of Macroeconomics, 2006, vol. 6, issue 1, 1-27

Abstract: We study standard monetary-policy rules with inflation-rate targets and either interest-rate or money-supply instruments using a flexible-price, perfect-foresight model. We focus mainly on interest-rate rules, but the results for money-supply rules are analogous. A locally-unique target equilibrium always exists. There are also below-target equilibria (BTE) with inflation below target and constant or asymptotically approaching or eventually reaching a below-target value. Liquidity traps are neither necessary nor sufficient for BTE. Such equilibria can also arise if monetary policy keeps the interest rate above a lower bound. We construct monetary-policy rules that preclude BTE. All are non-monotonic and discontinuous in current inflation. Each implies a difference equation in inflation. Some of these difference equations are continuous, but others are not. They are all non-monotonic and non-differentiable at a point. We argue that Japan's difficulties in the 1990s were probably the result of a stabilization problem rather than an indeterminacy problem.

Keywords: monetary policy; zero bound; liquidity trap; inflation targeting; indeterminacy (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (21)

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Related works:
Working Paper: Price-level determinacy, lower bounds on the nominal interest rate, and liquidity traps (2006)
Working Paper: Price-level determinacy, lower bounds on the nominal interest rate, and liquidity traps (2004)
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DOI: 10.2202/1534-6005.1437

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