A Monetary Policy Rule for Automatic Prevention of a Liquidity Trap
45 Pages Posted: 17 Sep 2012 Last revised: 18 Sep 2022
Date Written: January 2005
Abstract
In analyses of "liquidity trap" problems associated with the zero lower bound (ZLB) on nominal interest rates, it is important to emphasize the difference between policy rule changes, intended to help escape an existing ZLB situation, and maintained policy rules designed so as to avoid ZLB situations. Analysis assuming that rule changes would lead to a new RE equilibrium immediately seems implausible. Accordingly, the paper focuses on the design of a rule that should retain stabilization effectiveness even if the economy is temporarily shocked into a ZLB situation. The rule considered is one that uses as its instrument variable a weighted average of an interest rate and the rate of depreciation of the nominal exchange rate. With a small weight attached to the depreciation term, it will be nearly irrelevant in normal situations but call for strong adjustments when the ZLB condition prevails. Stabilizing properties of this "MC" rule are studied within a small open economy model developed by McCallum and Nelson. Results indicate that under ZLB conditions the MC rule will provide strong stabilizing policy actions yet, under conditions such that the ZLB constraint is not relevant, the MC rule need not hinder monetary policy.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Business Cycle Phases in U.S. States
By Howard J. Wall, Michael Owyang, ...
-
Is the United States an Optimum Currency Area? An Empirical Analysis of Regional Business Cycles
-
Regional Disparities in the Transmission of Monetary Policy
By Howard J. Wall and Michael Owyang
-
Structural Breaks and Regional Disparities in the Transmission of Monetary Policy
By Michael Owyang and Howard J. Wall
-
How Strong is Co-Movement in Employment Over the Business Cycle? Evidence from State/Industry Data
-
Regional Vars and the Channels of Monetary Policy
By Michael Owyang and Howard J. Wall
-
The Propagation of Regional Recessions
By James D. Hamilton and Michael Owyang