Inflation Targeting and the Liquidity Trap

Download or read book Inflation Targeting and the Liquidity Trap written by Bennett T. McCallum and published by . This book was released on 2001 with total page 58 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.