The perils of Taylor rules

Since John Taylor's (1993, Carnegie-Rochester Conf. Ser. Publ Policy 39, 19 5-214), seminal paper, a large literature has argued that active interest r ate feedback rules, that is: rules that respond to increases in inflation w ith a more than one-for-one increase in the nominal interest rate, are stab ilizing. In this paper, we argue that once the zero bound on nominal intere st rates is taken into account, active interest rate feedback rules can eas ily lead to unexpected consequences. Specifically, we show that even if the steady stale at which monetary policy is active is locally the unique equi librium, typically there exist an infinite number of equilibrium trajectori es originating arbitrarily close to that steady state that converge to a li quidity trap, that is, a steady state in which the nominal interest rate is near zero and inflation is possibly negative. Journal of Economic Literatu re Classification Numbers: E52, E31, E63. (C) 2001 Academic Press.