Determinacy and E-stability with Interest Rate Rules at the Zero Lower Bound

Abstract

This paper examines the uniqueness and learnability of rational expectations equilibrium when the policy rate is occasionally pegged at the zero lower bound (ZLB). We consider a model that features recurring, transient ZLB regimes and compare various interest rate rules which respond to inflation, price level, and average inflation in addition to output. In this environment, determinacy conditions ensure a unique equilibrium, given the recurrence of ZLB events, and E-stability conditions can rule out deflationary spirals under learning. We fi nd that price level targeting, including nominal income targeting as a special case, most effectively promotes determinacy and E-stability among the policy frameworks, while the economy under a standard inflation targeting rule is prone to indeterminacy. Average inflation targeting can promote determinacy and E-stability very effectively, provided that the measure of average inflation is sufficiently backward looking.