Liquidity Traps: an Interest‐rate‐based Exit Strategy

Abstract

This paper proposes a strategy for escaping liquidity traps based on an augmented Taylor‐type interest‐rate feedback rule that differs from usual specifications in that when inflation falls below a threshold, the central bank temporarily deviates from the traditional Taylor rule by following a deterministic path for the nominal interest rate that reaches the intended target for this policy instrument in finite time. The proposed policy is designed to set a floor on inflationary expectations. Importantly, the effectiveness of the proposed exiting strategy does not rely on the existence of an accompanying fiscalist (or non‐Ricardian) fiscal stance.

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