Escaping a Liquidity Trap: Keynes’ Prescription Is Right But His Reasoning Is Wrong
AbstractKeynes’ original intention in introducing the concept of a liquidity trap was to explain the reason why persistent large amounts of unutilized resources were generated during the Great Depression. This paper shows that this type of phenomenon cannot be explained in the framework of a traditional competitive market equilibrium. Instead, it can be understood in terms of a Nash equilibrium consisting of strategies of choosing a Pareto inefficient transition path because a Nash equilibrium can conceptually coexist with Pareto inefficiency. Such a Nash equilibrium will be selected when an upwards time preference shock occurs. At this Nash equilibrium, monetary policies are useless but fiscal policies are very effective as Keynes argued, but for different reasons.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 48115.
Date of creation: 08 Jul 2013
Date of revision:
Liquidity trap; Monetary policy; Fiscal policy; Pareto inefficiency; Time preference;
Find related papers by JEL classification:
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-07-15 (All new papers)
- NEP-MAC-2013-07-15 (Macroeconomics)
- NEP-MON-2013-07-15 (Monetary Economics)
- NEP-PKE-2013-07-15 (Post Keynesian Economics)
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