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Liquidity Trap Prevention and Escape: A Simple Proposition

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  • Junning Cai

Abstract

Liquidity traps occur when the natural nominal interest rate becomes negative. In a model with capital price dynamics explicitly considered, we find that shocks in the future can cause current and lasting liquidity traps. We propose that the central bank can prevent or fix liquidity traps by appending to its inflation-targeting monetary policy with a prioritized promise to defend a lower bound of nominal capital price. (JEL E31, E43, E44, E52, E58, E61, G12) Keywords: Liquidity traps; Zero interest bound; Asset Prices; Lower capital price bound

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Paper provided by EconWPA in its series Macroeconomics with number 0402033.

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Date of creation: 29 Feb 2004
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Handle: RePEc:wpa:wuwpma:0402033

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Keywords: Liquidity traps; Zero interest bound; Asset Prices; Lower capital price bound;

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  12. Svensson, Lars, 2000. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Seminar Papers 687, Stockholm University, Institute for International Economic Studies.
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  22. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap," IMF Working Papers 03/64, International Monetary Fund.
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