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Liquidity Trap and the Conditional Policy Commitment: An Analysis under Adaptive Learning

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  • Siddhartha Chattopadhyay

    (Siddhartha Chattopadhyay, Vinod Gupta School of Management, IIT Kharagpur, India. E-mail: chattopadhyay.siddhartha@gmail.com)

Abstract

A liquidity trap is no longer a mere theoretical curiosity after Japan’s economic slump in the early 1990s and the recent global recession triggered by economic depression in the United States in 2007. Several non-standard policy alternatives have been prescribed to combat a liquidity trap. One of them is the conditional policy commitment that keeps nominal interest rate near zero depending on the state of the economy. Such a credible commitment is expected to stimulate the economy by raising asset prices. Using the principle of adaptive learning, this article analyzes the impact of a conditional policy commitment on a liquidity trap, which keeps nominal interest rate near zero when the inflation rate is below a unique threshold level. I would show that a conditional policy commitment like this eliminates a liquidity trap and the associated deflationary spiral by anchoring inflationary expectations. As a result, the targeted equilibrium becomes globally stable. JEL Classification: E63, E52, E58

Suggested Citation

  • Siddhartha Chattopadhyay, 2013. "Liquidity Trap and the Conditional Policy Commitment: An Analysis under Adaptive Learning," South Asian Journal of Macroeconomics and Public Finance, , vol. 2(1), pages 1-32, June.
    • Handle: RePEc:sae:smppub:v:2:y:2013:i:1:p:1-32
    DOI: 10.1177/2277978713482201
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    References listed on IDEAS

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    Cited by:

    1. Chattopadhyay, Siddhartha & Ghosh, Taniya, 2020. "Taylor Rule implementation of the optimal policy at the zero lower bound: Does the cost channel matter?," Economic Modelling, Elsevier, vol. 89(C), pages 351-366.
    2. Subhasankar Chattopadhyay, 2019. "The Macroeconomics of Demonetization: Theory and Some Conjectures," South Asian Journal of Macroeconomics and Public Finance, , vol. 8(2), pages 118-143, December.

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    More about this item

    Keywords

    Adaptive learning; monetary policy; fiscal policy; zero interest rate lower bound;
    All these keywords.

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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