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Scarcity of safe assets, inflation, and the policy trap

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  • Andolfatto, David
  • Williamson, Stephen

Abstract

A goal of this paper is to make sense of the seemingly puzzling behavior of interest rates and inflation – and the role of central banks in that behavior – during and after the Great Recession, particularly in the United States. To this end, we construct a model in which government debt plays a key role in exchange, and can bear a liquidity premium. If asset market constraints bind, then there need not be deflation under an indefinite zero interest rate policy (ZIRP). Further, ZIRP may not be optimal under these circumstances. A Taylor-rule central banker could be subject to a ZIRP trap and persistently undershoot target inflation. As well, a liquidity premium on government debt creates additional Taylor rule perils, because of a persistently low real interest rate. We make a case that this is the key policy predicament currently faced by many central banks in the world.

Suggested Citation

  • Andolfatto, David & Williamson, Stephen, 2015. "Scarcity of safe assets, inflation, and the policy trap," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 70-92.
  • Handle: RePEc:eee:moneco:v:73:y:2015:i:c:p:70-92 DOI: 10.1016/j.jmoneco.2015.03.008
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    References listed on IDEAS

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    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The End of Central Banking
      by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2016-02-14 22:52:00
    2. Attitude Adjustment
      by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2016-06-22 03:42:00
    3. Low Real Interest Rates and Monetary Policy
      by Stephen Williamson in Stephen Williamson: New Monetarist Economics on 2017-03-30 02:41:00

    Citations

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    Cited by:

    1. Piazza, Roberto, 2016. "Self-fulfilling deflations," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 18-40.
    2. Michael Bordo & Robert N McCauley, 2017. "Triffin: dilemma or myth?," BIS Working Papers 684, Bank for International Settlements.
    3. Duarte, Fernando M., 2016. "How to escape a liquidity trap with interest rate rules," Staff Reports 776, Federal Reserve Bank of New York, revised 01 Dec 2016.
    4. Williamson, Stephen D., 2015. "Interest on Reserves, Interbank Lending, and Monetary Policy," Working Papers 2015-24, Federal Reserve Bank of St. Louis.
    5. Stephen D. Williamson, 2016. "Current Federal Reserve Policy under the Lens of Economic History: A Review Essay," Journal of Economic Literature, American Economic Association, pages 922-934.
    6. Stephen D. Williamson, 2016. "Current Federal Reserve Policy under the Lens of Economic History: A Review Essay," Journal of Economic Literature, American Economic Association, pages 922-934.
    7. Herrenbrueck, Lucas & Geromichalos, Athanasios, 2017. "A tractable model of indirect asset liquidity," Journal of Economic Theory, Elsevier, pages 252-260.
    8. Athanasios Geromichalos & Lucas Herrenbrueck, 2017. "The Liquidity-Augmented Model of Macroeconomic Aggregates," Discussion Papers dp17-16, Department of Economics, Simon Fraser University.
    9. Mathieu Boullot, 2017. "Secular Stagnation, Liquidity Trap and Rational Asset Price Bubbles," Working Papers halshs-01295012, HAL.

    More about this item

    Keywords

    Safe assets; Collateral; Policy trap; Monetary policy;

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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