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Central Bank Communication and the Liquidity Trap
Author(s) -
EUSEPI STEFANO
Publication year - 2010
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2009.00291.x
Subject(s) - monetary policy , transparency (behavior) , economics , liquidity trap , central bank , market liquidity , taylor rule , inflation (cosmology) , monetary economics , inflation targeting , welfare , forward guidance , deflation , general equilibrium theory , economic welfare , macroeconomics , liquidity risk , market economy , credit channel , computer science , physics , computer security , theoretical physics
Central bank communication plays an important role in shaping market participants' expectations. This paper studies a simple nonlinear model of monetary policy where agents have incomplete information about the economic environment. It shows that agents' learning and the dynamics of the economy are heavily affected by central bank's transparency about its policy rule. A monetary authority that does not communicate its rule can induce “learning equilibria” where the economy experiences prolonged periods of deflation and slow growth. More generally, small expectational errors can result in complex economic dynamics, inducing welfare‐reducing fluctuations. On the contrary, central bank communication helps stabilizing expectations around the inflation target equilibrium.