TY  - JOUR
AU  - García-Schmidt, Mariana
AU  - Woodford, Michael
TI  - Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 21614
PY  - 2015
Y2  - October 2015
DO  - 10.3386/w21614
UR  - http://www.nber.org/papers/w21614
L1  - http://www.nber.org/papers/w21614.pdf
N1  - Author contact info:
Mariana García-Schmidt
Central Bank of Chile
Agustinas 1180
Santiago, Chile
E-Mail: m.garcia.schmidt@gmail.com

Michael Woodford
Department of Economics
Columbia University
420 W. 118th Street
New York, NY 10027
Tel: 212/854-1094
Fax: 212-854-8059
E-Mail: mw2230@columbia.edu
AB  - We illustrate a pitfall that can result from the common practice of assessing alternative monetary policies purely by considering the perfect foresight equilibria (PFE) consistent with the proposed rule. In a standard New Keynesian model, such analysis may seem to support the “Neo-Fisherian” proposition according to which low nominal interest rates can cause inflation to be lower. We propose instead an explicit cognitive process by which agents may form their expectations of future endogenous variables. Under some circumstances, a PFE can arise as a limiting case of our more general concept of reflective equilibrium, when the process of reflection is pursued sufficiently far. But we show that an announced intention to fix the nominal interest rate for a long enough period of time creates a situation in which reflective equilibrium need not resemble any PFE. In our view, this makes PFE predictions not plausible outcomes in the case of such policies. Our alternative approach implies that a commitment to keep interest rates low should raise inflation and output, though by less than some PFE analyses apply.
ER  -