scholarly journals Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap

2013 ◽  
Vol 5 (3) ◽  
pp. 190-228 ◽  
Author(s):  
David Cook ◽  
Michael B Devereux
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Optimal Policy ◽  
Liquidity Trap ◽  
Relative Prices ◽  
Policy Responses ◽  
Global Liquidity ◽  
Initial Shock ◽  
Monetary And Fiscal Policy ◽  
Zero Bound

This paper analyzes optimal policy responses to a global liquidity trap. The key feature of this environment is that relative prices respond perversely. A fall in demand in one country causes an appreciation of its terms of trade, exacerbating the initial shock. At the zero bound, this country cannot counter this shock. Then it may be optimal for the partner country to raise interest rates. The partner may set a positive policy interest rate, even though its “natural interest rate” is below zero. An optimal policy response requires a mutual interaction between monetary and fiscal policy. (JEL E12, E32, E44, E52, E62, F44, G01)

scholarly journals REAL RIGIDITIES AND OPTIMAL STABILIZATION AT THE ZERO LOWER BOUND IN NEW KEYNESIAN ECONOMIES

2017 ◽  
Vol 23 (4) ◽  
pp. 1371-1400 ◽  
Author(s):  
Adiya Belgibayeva ◽  
Michal Horvath
Keyword(s):  
Lower Bound ◽  
Interest Rates ◽  
Optimal Policy ◽  
New Keynesian ◽  
Zero Lower Bound ◽  
Wage Setting ◽  
Optimal Stabilization ◽  
Labor Market Segmentation ◽  
Policy Responses ◽  
New Keynesian Models

The paper revisits the literature on real rigidities in New Keynesian models in the context of an economy at the zero lower bound. It identifies strategic interaction among price- and wage-setting agents in the economy as an important determinant of both optimal policy and economic dynamics in deep recessions. In particular, labor market segmentation is shown to have a significant influence on the length of the forward commitment to keep interest rates at zero, the magnitude of the fiscal policy responses as well as inflation volatility in the economy under optimal policy.

scholarly journals Was the New Deal Contractionary?

2012 ◽  
Vol 102 (1) ◽  
pp. 524-555 ◽  
Author(s):  
Gauti B Eggertsson
Keyword(s):  
United States ◽  
Interest Rate ◽  
Interest Rates ◽  
New Deal ◽  
The United States ◽  
Government Policies ◽  
Short Term ◽  
The Great Depression ◽  
Zero Bound ◽  
The New Deal

Can government policies that increase the monopoly power of firms and the militancy of unions increase output? This paper shows that the answer is yes under certain “emergency” conditions. These emergency conditions—zero interest rates and deflation—were satisfied during the Great Depression in the United States. The New Deal, which facilitated monopolies and union militancy, was therefore expansionary in the model presented. This conclusion is contrary to a large previous literature. The main reason for this divergence is that this paper incorporates rigid prices and the zero bound on the short-term interest rate. JEL: E23, E32, E52, E62, J51, N12, N42

scholarly journals 'Captivated by Liquidity' – Theoretical Traps and Practical Mazes

2021 ◽  
Vol 66 (1) ◽  
pp. 50-67
Author(s):  
Zsuzsanna Novák ◽  
Tibor Tatay
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Global Financial Crisis ◽  
Great Influence ◽  
Economic Recession ◽  
Central Banks ◽  
Liquidity Trap ◽  
Theoretical Approaches ◽  
Lower Interest Rate ◽  
The Usa

There is no uniform theoretical standpoint on the effects of changing interest rates and the role of money among economists. Though these disputes exercise a great influence on the economic policy measures adopted as well. For the management of the 2008 global financial crisis many central banks entered into forceful interest rate cuts to contribute to the revitalisation of the economy. The economic recession caused by the pandemic of 2020 again raises the issue how central banks can stimulate growth. In this study we deal with the liquidity trap issue attributed to Keynes. Keynes pointed out that there might exist a lower interest rate limit under which money demand becomes infinite. His conceptions put the foundations to the question, at what interest rate levels might the liquidity trap – a term coined later by Robertson – phenomenon become effective. He was followed by numerous renowned economists dealing with the conception. In this paper we are discussing the most important theoretical approaches – among others the views of Hansen, Hicks, Tobin, Patinkin, Krugman, Brunner and Meltzer and Eggertson. We provide an overview on the effects of low interest rate levels adopted by Japan, by the central banks of Japan, the USA and the ECB aimed at stimulating the economy. Based on the study it can be confirmed that central banks can contribute to economic growth keeping interest rates low and therewith fostering investment. Nevertheless, beyond keeping short-term interest rates low, it might be adequate to control interest rates of other maturities and, especially under deflationary expectations, central banks should express their prolonged commitment to low interest rates.

Markov Branching Decision Chains with Interest-Rate-Dependent Rewards

1995 ◽  
Vol 9 (1) ◽  
pp. 99-121 ◽  
Author(s):  
Ying Huang ◽  
Arthur F. Veinott
Keyword(s):  
Interest Rate ◽  
Interest Rates ◽  
Optimal Policy ◽  
Linear Program ◽  
Present Value ◽  
Constraint Matrix ◽  
Rate Dependent ◽  
Markov Decision ◽  
The Interest Rate ◽  
The One

Finite-state-and-action Markov branching decision chains are studied with bounded endogenous expected population sizes and interest-rate-dependent one-period rewards that are analytic in the interest rate at zero. The existence of a stationary strong-maximum-present-value policy is established. Miller and Veinott's [1969] strong policy-improvement method is generalized to find in finite time a stationary n-present-value optimal policy and, when the one-period rewards are rational in the interest rate, a stationary strong-maximum-present-value policy. This extends previous studies of Blackwell [1962], Miller and Veinott [1969], Veinott [1974], and Rothblum [1974, 1975], in which the one-period rewards are independent of the interest rate, and Denardo [1971] in which semi-Markov decision chains with small interest rates are studied. The problem of finding a stationary n-present-value optimal policy is also formulated as a staircase linear program in which the objective function and right-hand sides, but not the constraint matrix, depend on the interest rate, and solutions for all small enough positive interest rates are sought. The optimal solutions of the primal and dual are polynomials in the reciprocal of the interest rate. A constructive rule is given for finding a stationary n-present-value optimal policy from an optimal solution of the asymptotic linear program. This generalizes the linear programming approaches for finding maximum-reward-rate and maximum-present-value policies for Markov decision chains studied by Manne [1960], d'Epenoux [1960, 1963], Balinski [1961], Derman [1962], Denardo and Fox [1968], Denardo [1970], Derman and Veinott [1972], Veinott [1973], and Hordijk and Kallenberg [1979, 1984].

Fiscal sustainability under entitlement spending

2020 ◽  
Author(s):  
Floriana Cerniglia ◽  
Enzo Dia ◽  
Andrew Hughes Hallett
Keyword(s):  
Public Sector ◽  
Panel Data ◽  
Interest Rates ◽  
Empirical Evidence ◽  
Optimal Policy ◽  
Fiscal Sustainability ◽  
The Public ◽  
Dynamic Framework ◽  
Policy Responses ◽  
The Stability

Abstract We develop a simple theoretical framework that can be used not only to assess the stability of debt, but also to evaluate the sustainability of the commitments of the public sector in the presence of entitlement spending. We model the optimal intertemporal path of fiscal variables and the optimal policy responses in this environment, which requires a dynamic framework. Our analysis suggests that even with near-zero interest rates the stability of debt is not guaranteed and that the sustainability of public finances depends on the level of taxes and the persistence of expenditure, as much as on the level of debt. We estimate the model with panel data techniques, finding that our modelling strategy is supported by the empirical evidence and we use calibrated versions of our model to compare different countries.

scholarly journals Holding Cash and Spontaneous Behavior: A Modification of the Baumol Equation

2017 ◽  
Vol 9 (1) ◽  
pp. 209
Author(s):  
Limor D. Gonen ◽  
Michal Weber ◽  
Tchai Tavor ◽  
Uriel Spiegel
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Interest Rates ◽  
Cash Holding ◽  
Purchasing Behavior ◽  
Liquidity Trap ◽  
Industrial Countries ◽  
Automatic Stabilizer ◽  
Spontaneous Behavior ◽  
The Interest Rate

During the decades following the presentation of the original Baumol equation (1952) the role of holding cash was significantly changed. The original Baumol equation considered the two elements of (i) the value of transactions, positively affecting cash holding; and (ii) the interest rate, negatively affecting cash holding. A third element that was not considered is the economic behavioral aspect of the availability of money that may lead to spontaneous purchasing. This element reduces the inclination of customers towards holding cash.The present paper develops various kinds of loss functions due to spontaneous purchasing behavior and presents several different modified Baumol equations that are more reliable and realistic than the original Baumol equation.An important implication of our paper relates to the ineffectiveness of monetary policy. When the interest rate is very low, in the original Baumol model we approach the liquidity trap range in which monetary policy is ineffective. However, according to our new model the monetary policy still remains effective, even at low or zero interest rates. This is the case even in an environment in which the monetary policy seems to be totally inefficient, as we recently find in several industrial countries throughout the world. In some sense, this reminds us of the idea of an automatic stabilizer that supports fiscal policies. The new modified Baumol equation in the current paper reveals an automatic stabilizer which accelerates the effectiveness of monetary policy, and avoids the phenomenon of the liquidity trap, even in cases of zero interest rates.

scholarly journals OPTIMAL STABILIZATION POLICY WITH SEARCH EXTERNALITIES

2013 ◽  
Vol 19 (3) ◽  
pp. 669-700 ◽  
Author(s):  
Aleksander Berentsen ◽  
Christopher Waller
Keyword(s):  
Monetary Policy ◽  
Interest Rate ◽  
Interest Rates ◽  
Money Demand ◽  
Optimal Policy ◽  
Stabilization Policy ◽  
Optimal Stabilization ◽  
Aggregate Shocks ◽  
Informational Frictions ◽  
Nominal Interest Rates

We study optimal monetary stabilization policy in a DSGE model with microfounded money demand. A search externality creates “congestion,” which causes aggregate output to be inefficient. Because of the informational frictions that give rise to money, households are unable to insure themselves perfectly against aggregate shocks. This gives rise to a welfare-improving role for monetary policy that works by adjusting the nominal interest rate in response to these shocks. Optimal policy is determined by choosing a set of state-contingent nominal interest rates to maximize the expected lifetime utility of the agents subject to the constraints of being an equilibrium.

CHINA'S NEW EXCHANGE RATE POLICY: WILL CHINA FOLLOW JAPAN INTO A LIQUIDITY TRAP?

2005 ◽  
Vol 50 (spec01) ◽  
pp. 463-474 ◽  
Author(s):  
RONALD I. MCKINNON
Keyword(s):  
Exchange Rate ◽  
Interest Rate ◽  
Interest Rates ◽  
Exchange Rate Policy ◽  
Foreign Exchange Risk ◽  
Liquidity Trap ◽  
Downward Pressure ◽  
Exchange Risk ◽  
Rate Policy ◽  
The One

Todays' American mercantile pressure on China to appreciate the renminbi against the dollar is eerily similar to the American pressure on Japan to appreciate the yen that began over 30 years ago. There are some differences between the two cases, but downward pressure on Chinese interest rates from foreign exchange risk could lead China into a zero interest rate liquidity trap much like the one that Japan has suffered since the mid-1990s.

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