The Perils of Taylor Rules

Jess Benhabib, Stephanie Schmitt-Grohe and Martín Uribe ()

No 2314, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Since John Taylor's (1993) seminal paper, a large literature has argued that active interest rate feedback rules, that is, rules that respond to increases in inflation with a more than one-for-one increase in the nominal interest rate, are stabilizing. In this paper, we argue that once the zero bound on nominal interest rates is taken into account, active interest rate feedback rules can easily lead to unexpected consequences. Specifically, we show that even if the steady state at which monetary policy is active, is locally the unique equilibrium, typically there exists an infinite number of equilibrium trajectories originating arbitrarily close to that steady state, that converge to a liquidity trap, that is, a steady state in which the nominal interest rate is near zero and inflation is possibly negative.

Keywords: Interest Rate Feedback Rules; Liquidity Trap; Zero Bound On Nominal Interest Rates (search for similar items in EconPapers)
JEL-codes: E31 E52 E63 (search for similar items in EconPapers)
Date: 1999-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (51)

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Related works:
Journal Article: The Perils of Taylor Rules (2001)
Working Paper: The Perils of Taylor Rules (1998)
Working Paper: The perils of Taylor Rules (1998)
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