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The Real Balance Effect

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  • Peter N. Ireland

Abstract

This paper extends a conventional cash-in-advance model to incorporate a real balance effect of the kind described by de Scitovszky, Haberler, Pigou, and Patinkin. When operative, this real balance effect eliminates the liquidity trap, allowing the central bank to control the price level even when the nominal interest rate hits its lower bound of zero. Curiously, the same mechanism that gives rise to the real balance effect also implies that monetary policies have distributional consequences that make some agents much worse off under a zero nominal interest rate than they are when the nominal interest rate is positive.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8136.

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Date of creation: Feb 2001
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Publication status: published as Ireland, Peter N. “The Liquidity Trap, the Real Balance Effect, and the Friedman Rule." International Economic Review (November 2005).
Handle: RePEc:nbr:nberwo:8136

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  1. Peter N. Ireland, 2002. "Implementing the Friedman Rule," NBER Working Papers 8821, National Bureau of Economic Research, Inc.
  2. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  3. William C. Whitesell, 1988. "Age heterogeneity and the Tobin effect with infinite horizons," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 4, Board of Governors of the Federal Reserve System (U.S.).
  4. Michael Mussa, 2000. "Summary panel: reflections on monetary policy at low inflation," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, pages 1100-1106.
  5. Harold L. Cole & Narayana R. Kocherlakota, 1998. "Zero nominal interest rates: why they're good and how to get them," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr, pages 2-10.
  6. Svensson, Lars, 1999. "How Should Monetary Policy Be Conducted in an Era of Price Stability," Seminar Papers, Stockholm University, Institute for International Economic Studies 680, Stockholm University, Institute for International Economic Studies.
  7. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, Econometric Society, vol. 68(2), pages 247-274, March.
  8. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," RCER Working Papers 155, University of Rochester - Center for Economic Research (RCER).
  9. McCallum, Bennett T., 1986. "Some issues concerning interest rate pegging, price level determinacy, and the real bills doctrine," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(1), pages 135-160, January.
  10. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(2), pages 223-47, April.
  11. Cohen, Daniel, 1985. "Inflation, wealth and interest rates in an intertemporal optimizing model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(1), pages 73-85, July.
  12. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 78(3), pages 402-17, June.
  13. Buiter, Willem H, 1988. "Death, Birth, Productivity Growth and Debt Neutrality," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 98(391), pages 279-93, June.
  14. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 18(2), pages 203-20, April.
  15. Woodford, Michael, 1990. "The optimum quantity of money," Handbook of Monetary Economics, Elsevier, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 20, pages 1067-1152 Elsevier.
  16. Weil, Philippe, 1991. "Is Money Net Wealth?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(1), pages 37-53, February.
  17. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
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Cited by:
  1. Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2004. "The Role of Money in Two Alternative Models: When is the Friedman Rule Optimal, and Why?," Staff General Research Papers, Iowa State University, Department of Economics 11950, Iowa State University, Department of Economics.
  2. C.A. Ullersma, 2001. "The Zero Lower Bound on Nominal Interest Rates and Monetary Policy Effectiveness: a Survey," MEB Series (discontinued), Netherlands Central Bank, Monetary and Economic Policy Department 2001-9, Netherlands Central Bank, Monetary and Economic Policy Department.
  3. Iwamoto, Yasushi, 2005. "Monetary and Fiscal Policy to Escape from a Deflationary Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(1), pages 1-46, February.
  4. Claus Brand & Hans-Eggert Reimers & Franz Seitz, 2003. "Narrow Money and the Business Cycle: Theoretical aspects and euro area evdence," Macroeconomics, EconWPA 0303012, EconWPA.
  5. Nelson, Edward, 2003. "The Future of Monetary Aggregates in Monetary Policy Analysis," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3897, C.E.P.R. Discussion Papers.
  6. Mauro Boianovsky, 2003. "The IS-LM Model and the Liquidity Trap Concept: from Hicks to Krugman," Anais do XXXI Encontro Nacional de Economia [Proceedings of the 31th Brazilian Economics Meeting], ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Gr a13, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  7. Hiebert, Paul & Pérez, Javier J. & Rostagno, Massimo, 2002. "Debt reduction and automatic stabilisation," Working Paper Series, European Central Bank 0189, European Central Bank.
  8. Fujiwara, Ippei, 2006. "Evaluating monetary policy when nominal interest rates are almost zero," Journal of the Japanese and International Economies, Elsevier, vol. 20(3), pages 434-453, September.
  9. William Barnett & Unja Chae & John Keating, 2005. "Forecast Design in Monetary Capital Stock Measurement," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 200516, University of Kansas, Department of Economics, revised Aug 2005.
  10. Pojanart Sunirand, 2003. "The role of money in the transmission mechanism of monetary policy: evidence from Thailand," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 24850, London School of Economics and Political Science, LSE Library.

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