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Title: Optimal institutional design when there is a zero lower bound on interest rates
Authors: Dhami, Sanjit
al-Nowaihi, Ali
First Published: 11-Jul-2011
Publisher: Oxford University Press (OUP)
Citation: Oxford Economic Papers, 2011, 63 (4), pp. 700-721.
Abstract: Given the recent experience, there is a growing interest in the liquidity trap, which occurs when the nominal interest rate reaches its zero lower bound. We outline the surprising policy recommendations when there is the possibility of a zero lower bound. Then, using the Dixit-Lambertini framework of strategic policy interaction between the Treasury and the Central Bank, we find that the optimal institutional response to the possibility of a liquidity trap has two main components. First, an optimal inflation target is given to the Central Bank. Second, the Treasury, which retains control over fiscal policy and acts as Stackelberg leader, is given optimal output and inflation targets. This institutional solution achieves the optimal rational expectations pre-commitment solution.
DOI Link: 10.1093/oep/gpr030
ISSN: 0030-7653
eISSN: 1464-3812
Version: Post-print
Status: Peer-reviewed
Type: Article
Rights: © Oxford University Press 2011. This is a pre-copy-editing, author-produced PDF of an article accepted for publication in Oxford Economic Papers following peer review. The definitive publisher-authenticated version [Oxf. Econ. Pap. (2011) 63 (4): 700-721] is available online at:
Appears in Collections:Published Articles, Dept. of Economics

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