Chaotic Interest-Rate Rules

A growing empirical and theoretical literature argues in favor of specifying monetary policy in the form of Taylor-type interest rate feedback rules. That is, rules whereby the nominal interest rate is set as an increasing function of inflation with a slope greater than one around an intended inflation target. This paper shows that because of the zero bound on nominal interest rates, such rules can easily lead to chaotic dynamics. The result is obtained in the context of standard and well-calibrated monetary environments. Furthermore, the battery of fiscal policies that have recently been advocated for avoiding liquidity traps are shown to be unlikely to provide a remedy for the kind of dynamics characterized in this paper. JEL Classification Numbers: E52, E31, E63.