The macroeconomics of financial crises: How risk premiums, liquidity traps and perfect traps affect policy options
AbstractThe paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only when interest rates approach zero but at positive and/or rising rates as well; (2) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (3) Near the fringe of liquidity traps, the risk arises of perfect traps, in which neither monetary nor fiscal policy works when used in isolation, but policy coordination is called for; and (4) Massive financial crises in the domestic money market may even destabilize the economy.
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Bibliographic InfoPaper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2009 with number 2009-15.
Length: 26 pages
Date of creation: Jul 2009
Date of revision:
financial crisis; credit crunch; liquidity trap; zero lower bound; risk premiums; policy options; fiscal policy; monetary policy; open economy.;
Find related papers by 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
- F01 - International Economics - - General - - - Global Outlook
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-08-02 (All new papers)
- NEP-CBA-2009-08-02 (Central Banking)
- NEP-MAC-2009-08-02 (Macroeconomics)
- NEP-MON-2009-08-02 (Monetary Economics)
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