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On Lower-bound Traps: A Framework for the Analysis of Monetary Policy in the ÒAgeÓ of Central Banks

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  • Alfonso Palacio-Vera
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    Abstract

    We present a simple theoretical framework that integrates the notion of the natural or neutral interest rate, liquidity preference theory, and the monetary policy practice by modern central banks. We claim that this theory explains the conditions under which an economy will experience an aggregate demand deficiency problem within a modern institutional setting. Contrary to the predictions of the New Consensus View in macroeconomics, the model suggests that ÒstructuralÓ factors such as a high saving rate and, especially, a low ÒnaturalÓ rate of growth increase the chances that an economy experiences an aggregate demand deficiency. Contrary to conventional wisdom, the model predicts that a fall in the NAIRU may lead to a rise in the natural interest rate, and vice versa.

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    Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_478.

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    Date of creation: Nov 2006
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    Handle: RePEc:lev:wrkpap:wp_478

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