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Inflation Targeting and Liquidity Traps Under Endogenous Credibility

Cars Hommes () and Joep Lustenhouwer

Staff Working Papers from Bank of Canada

Abstract: Policy implications are derived for an inflation-targeting central bank, whose credibility is endogenous and depends on its past ability to achieve its targets. This is done in a New Keynesian framework with heterogeneous and boundedly rational expectations. We find that the region of allowed policy parameters is strictly larger than under rational expectations. However, when the zero lower bound on the nominal interest rate is accounted for, self-fulfilling deflationary spirals can occur, depending on the credibility of the central bank. Deflationary spirals can be prevented with a high inflation target and aggressive monetary easing.

Keywords: Business fluctuations and cycles; Credibility; Monetary policy (search for similar items in EconPapers)
JEL-codes: E52 E32 C62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2019-02
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Related works:
Working Paper: Inflation Targeting and Liquidity Traps under Endogenous Credibility (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:19-9

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