In most standard (Dynamic Stochastic General Equilibrium, DSGE) macro-models, there is a single riskless rate, set by the Central Bank in accord with some reaction function, as developed by John Taylor (1993/1999). In this model all agents can lend and borrow at this same rate, because default, and hence credit risk, is assumed away. The one extra degree of freedom that a Central Bank may have in such a model is to play on the public’s expectations of their future policy. In particular, some have argued that, should a lower, zero bound to nominal interest rates be hit in a depression, then the Central Bank should publicly aim to achieve higher future inflation in order to lower real interest rates now. But this is dangerous for two reasons.
Publication Date
Financial Markets Group Special Papers SP 219
