April 2004

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

Ragna Alstadheim and Dale W. Henderson


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.

Full paper (screen reader version)

Keywords: Price-level indeterminacy, multiple equilibria, zero bound, monetary policy, monetary rule, fiscal policy, money demand

PDF: Full Paper

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Last Update: January 11, 2021