Discussion Paper Series 2018-E-6

Speed Limit Policy and Liquidity Traps

Taisuke Nakata, Sebastian Schmidt, Paul Yoo

The zero lower bound (ZLB) constraint on interest rates makes speed limit policies (SLPs)--policies aimed at stabilizing the output growth--less effective. Away from the ZLB, the history dependence induced by a concern for output growth stabilization improves the inflation-output tradeoff for a discretionary central bank. However, in the aftermath of a deep recession with a binding ZLB, a central bank with an objective for output growth stabilization aims to engineer a more gradual increase in output than under the standard discretionary policy. The anticipation of a more restrained recovery exacerbates the declines in inflation and output when the lower bound is binding.

Keywords: Liquidity Traps; Markov-Perfect Equilibrium; Speed Limit Policy; Zero Lower Bound

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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