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Scarcity of safe assets, inflation, and the policy trap

Listed author(s):
  • Andolfatto, David
  • Williamson, Stephen

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.

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File URL: http://www.sciencedirect.com/science/article/pii/S0304393215000495
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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 73 (2015)
Issue (Month): C ()
Pages: 70-92

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Handle: RePEc:eee:moneco:v:73:y:2015:i:c:p:70-92
DOI: 10.1016/j.jmoneco.2015.03.008
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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  1. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
  2. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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  9. Williamson, Stephen D., 2014. "Low Real Interest Rates, Collateral Misrepresentation, and Monetary Policy," Working Papers 2014-26, Federal Reserve Bank of St. Louis, revised 29 Aug 2014.
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  13. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
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  16. Stephen D. Williamson, 2012. "Liquidity, Monetary Policy, and the Financial Crisis: A New Monetarist Approach," American Economic Review, American Economic Association, vol. 102(6), pages 2570-2605, October.
  17. Ivan Werning, 2011. "Managing a Liquidity Trap: Monetary and Fiscal Policy," 2011 Meeting Papers 1435, Society for Economic Dynamics.
  18. Williamson, Stephen D., 2016. "Scarce collateral, the term premium, and quantitative easing," Journal of Economic Theory, Elsevier, vol. 164(C), pages 136-165.
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