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.
