Working Paper

Price-level determinacy, lower bounds on the nominal interest rate, and liquidity traps

Abstract: We consider monetary-policy rules with inflation-rate targets and interest-rate or money-growth instruments using a flexible-price, perfect-foresight model. There is always a locally-unique target equilibrium. There may also be below-target equilibria (BTE) with inflation always below target and constant, asymptotically approaching or eventually reaching a below-target value, or oscillating. Liquidity traps are neither necessary nor sufficient for BTE which can arise if monetary policy keeps the interest rate above a lower bound. We construct monetary rules that preclude BTE when fiscal policy does not. Plausible fiscal policies preclude BTE for any monetary policy; those policies exclude surpluses and, possibly, balanced budgets.

Keywords: Interest rates; Prices; Monetary policy; Econometric models;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2004

Number: 795