Reputation and Liquidity Traps

Taisuke Nakata

No 61, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies credible policies in a New Keynesian economy in which the nominal interest rate is subject to the ZLB constraint and contractionary shocks hit the economy occasionally. The Ramsey policy involves keeping the policy rate low even after the shock disappears, but the central bank would be tempted to raise the rate to close consumption and inflation gaps if it could re-optimize. I find that the Ramsey policy is credible if the contractionary shock occurs sufficiently frequently. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, and keeps the central bank on the originally announced path of low nominal interest rates.

Date: 2014
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (23)

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Journal Article: Reputation and Liquidity Traps (2018)
Working Paper: Reputation and Liquidity Traps (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:61

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