Liquidity Traps and the Price (In)Determinacy of Monetary Rules

This paper proposes a new methodology for assessing price indeterminacy to supplant the discredited nonexplosive criterion. Using this methodology, we find that nominal GDP targeting and price-level targeting do determine prices when the central bank follows a sufficiently strong feedback rule for setting the nominal interest rate. However, inflation targeting leads to price indeterminacy, a result consistent with the principles of calculus. This price indeterminacy of inflation targeting could manifest itself in a liquidity trap or zero bound for nominal interest rates rendering central banks impotent. Nominal GDP targeting could overcome this liquidity-trap effect.