A BEJM Contributions article.

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.

Submitted: March 30, 2006 · Accepted: October 7, 2006 · Published: November 2, 2006

Originally published in Contributions to Macroeconomics.

Recommended Citation

Alstadheim, Ragna and Henderson, Dale W. (2006) "Price-Level Determinacy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps," Contributions to Macroeconomics: Vol. 6 : Iss. 1, Article 12.
Available at: http://www.bepress.com/bejm/contributions/vol6/iss1/art12