Reputation and liquidity traps

Can the central bank credibly commit to keeping the nominal interest rate low for an extended period of time in the aftermath of a deep recession? By analyzing credible plans in a sticky-price economy with occasionally binding zero lower bound constraints, I find that the answer is yes if contractio...

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Bibliographic Details
Published inReview of economic dynamics Vol. 28; pp. 252 - 268
Main Author Nakata, Taisuke
Format Journal Article
LanguageEnglish
Published Elsevier Inc 01.04.2018
Subjects
Credible policy
Forward guidance
Liquidity trap
Reputation
Sustainable plan
Zero lower bound
E62
E61
Zero lower bound
E52
E63
E32
Forward guidance
Credible policy
Liquidity trap
Reputation
Sustainable plan
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Summary:Can the central bank credibly commit to keeping the nominal interest rate low for an extended period of time in the aftermath of a deep recession? By analyzing credible plans in a sticky-price economy with occasionally binding zero lower bound constraints, I find that the answer is yes if contractionary shocks hit the economy with sufficient frequency. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. Even with a very small probability of future contractionary shocks, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps and keeps the central bank on the originally announced path of low nominal interest rates.
ISSN:1094-2025
1096-6099
DOI:10.1016/j.red.2017.09.001