NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Inflation Targeting and the Liquidity Trap

Bennett T. McCallum

NBER Working Paper No. 8225
Issued in April 2001
NBER Program(s):   EFG   ME

This paper considers whether 'liquidity trap' issues have important bearing on the desirability of inflation targeting as a strategy for monetary policy. From a theoretical perspective, it has been suggested that 'expectation trap' and 'indeterminacy' dangers are created by variants of inflation targeting, the latter when forecasts of future inflation enter the policy rule. This paper argues that these alleged dangers are probably not of practical importance. From an empirical perspective, a quantitative open-economy model is developed and the likelihood of encountering a liquidity trap is explored for several policy rules. Also, it is emphasized that, if the usual interest rate instrument is immobilized by a liquidity trap, there is still an exchange-rate channel by means of which monetary policy can exert stabilizing effects. The relevant target variable can still be the inflation rate.

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Document Object Identifier (DOI): 10.3386/w8225

Published:

  • Bennett McCallum, 2001. "Inflation targeting and the liquidity trap," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  • Bennett McCallum, 2002. "Inflation Targeting and the Liquidity Trap," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.), Inflation Targeting: Desing, Performance, Challenges, edition 1, volume 5, chapter 9, pages 395-438 Central Bank of Chile.

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