A Microfoundation for Keynes' Speculative Motive and the Liquidity Trap

Prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations ineffective for achieving macroeconomic stabilization goals. We show that even were this the case, there remains a powerful argument for large-scale open market operations as a fiscal policy tool. As we also demonstrate, however, this same reasoning implies that open-market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open-market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan’s recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japan’s predicament. We argue Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.

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Optimal Monetary and Fiscal Policy in a Liquidity Trap [with Comments]

NBER International Seminar on Macroeconomics ◽

10.1086/653955 ◽

2004 ◽

Vol 2004 (1) ◽

pp. 75-144

Author(s):

Gauti B. Eggertsson ◽

Michael Woodford ◽

Tor Einarsson ◽

Eric M. Leeper

Keyword(s):

Fiscal Policy ◽

Liquidity Trap ◽

Monetary And Fiscal Policy

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MONETARY POLICY SWITCHING IN THE EURO AREA AND MULTIPLE STEADY STATES: AN EMPIRICAL INVESTIGATION

Macroeconomic Dynamics ◽

10.1017/s1365100515000280 ◽

2016 ◽

Vol 21 (5) ◽

pp. 1175-1188 ◽

Cited By ~ 1

Author(s):

Gilles Dufrénot ◽

Guillaume A. Khayat

Keyword(s):

Steady State ◽

Euro Area ◽

European Central Bank ◽

Empirical Investigation ◽

Standard Assumption ◽

Demand Shock ◽

Liquidity Trap ◽

European Central ◽

Parameter Values ◽

Policy Function

This paper investigates, in the case of the euro area, the standard assumption that the liquidity trap steady state, which arises from the existence of the zero lower bound on the nominal interest rate, is locally unstable. We show that the policy function of the European Central Bank (ECB) is described by a nonlinear Taylor rule. Then, using our estimations, we show that around the liquidity trap steady state the equilibrium is locally determinate for most plausible parameter values. Finally, we find that an inflation shock is more efficient than a demand shock to escape the liquidity trap steady state.

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