Policy Options in a Liquidity Trap
By Gauti B. Eggertsson, Michael Woodford. 2004
132 citations recorded by the source corpus.
The specter of a “liquidity trap,” originally proposed as a theoretical possibility by John Maynard Keynes (1936) but long considered to be of doubtful practical relevance, has recently created alarm among the world’s central banks. In Japan, the overnight rate has been essentially at zero for most of the time since February 1999, making further interest-rate cuts impossible. Yet until well into 2003, growth remained anemic while prices continued to fall, suggesting a need for further monetary stimulus. Since March 2001, the Bank of Japan has supplemented its “zero-interest-rate policy” with a policy of “quantitative easing,” under which additional bank reserves are supplied beyond those needed to keep overnight interest rates at zero. Yet an increase in base money of more than 50 percent failed to halt the deflation, suggesting a liquidity trap. More recently, other central banks, including the Fed, have come close enough to the zero bound to worry about how they would deal with a similar predicament. Here we first discuss whether monetary policy should actually become ineffective when the zero bound on interest rates is reached. We argue that open-market operations, even of “unconventional” types, will be ineffective if they do not change expectations about the future conduct of policy; in this sense, a liquidity trap is possible. Nonetheless, a credible commitment regarding future policy can largely mitigate the distortions created by the zero bound. We fully characterize the optimal commitment in a simple example.
Subfields: Economics and Econometrics, Finance
View Paper: https://www.semanticscholar.org/paper/812920fbc69351aab81b039b848092e57fb86928
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In Economics and Econometrics
- Olivier Coibion
- Y. Gorodnichenko
- J. Wieland
- Michael Weber
- V. Ramey
- Nicholas Barberis
- Raphael S. Schoenle
- Alberto Cavallo
In Finance
Citations in the corpus
- The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound? (2012, methodology): “Our approach for modeling the zero bound follows Bodenstein, Erceg and Guerreri (2009) by solving for the duration of the zero bound endogenously, unlike in Christiano et al. (2011) or Eggertsson and Woodford (2004).”