Inflation targets and the liquidity trap

Abstract

The presence of a lower bound of zero on nominal interest rate has important implications for the conduct of optimal monetary policy. Standard rational expectations models can have alternative steady states as well as non-unique laws of motion, i.e. there can be possible sunspot equilibria. Such complications can be ruled out under a number of alternative assumptions. In this paper we analyse the relevance of the zero lower bound for alternative levels of inflation in a standard Neo-Keynesian model, where stability is assured by assuming that fiscal policy turns expansionary at the zero lower bound.