Working Paper: NBER ID: w11056
Authors: Bennett T. McCallum
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. \nThe 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.
Keywords: No keywords provided
JEL Codes: E52; E3; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| MC rule (C30) | economic stability (E63) |
| ZLB conditions (E31) | MC rule effectiveness (E61) |
| MC rule (C30) | inflation fluctuations (E31) |
| MC rule (C30) | output fluctuations (E39) |
| MC rule (C30) | avoidance of liquidity traps (E41) |
| interest rate and nominal exchange rate (E43) | MC rule adjustment (E61) |