Optimal Monetary Policy, Inflation Targeting and the Zero Bound on the Interest Rate

Ragna Alstadheim — Wed, 20 Dec 2006 03:17:37 PST

Is the price level in Norway determined by fiscal policy?

Ragna Alstadheim — Tue, 19 Dec 2006 06:01:02 PST

Price-Level Determinacy, Lower Bounds on the Nominal Interest Rate, and Liquidity Traps

Ragna Alstadheim et al. — Tue, 19 Dec 2006 04:40:35 PST

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.