Article ID Journal Published Year Pages File Type
7368818 Journal of Monetary Economics 2015 47 Pages PDF
Abstract
A goal of this paper is to make sense of the seemingly puzzling behavior of interest rates and inflation - and the role of central banks in that behavior - during and after the Great Recession, particularly in the United States. To this end, we construct a model in which government debt plays a key role in exchange, and can bear a liquidity premium. If asset market constraints bind, then there need not be deflation under an indefinite zero interest rate policy (ZIRP). Further, ZIRP may not be optimal under these circumstances. A Taylor-rule central banker could be subject to a ZIRP trap and persistently undershoot target inflation. As well, a liquidity premium on government debt creates additional Taylor rule perils, because of a persistently low real interest rate. We make a case that this is the key policy predicament currently faced by many central banks in the world.
Related Topics
Social Sciences and Humanities Economics, Econometrics and Finance Economics and Econometrics
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