IDEAS home Printed from https://ideas.repec.org/a/eee/moneco/v73y2015icp70-92.html
   My bibliography  Save this article

Scarcity of safe assets, inflation, and the policy trap

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0304393215000495
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. 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.
    2. 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.
    3. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-1171, December.
    4. 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.
    5. Williamson, Stephen D., 2014. "Low Real Interest Rates, Collateral Misrepresentation, and Monetary Policy," Working Papers 2014-26, Federal Reserve Bank of St. Louis, revised 09 Sep 2016.
    6. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
    7. Huberto Ennis, 2014. "A simple general equilibrium model of large excess reserves," 2014 Meeting Papers 1357, Society for Economic Dynamics.
    8. 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.
    9. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May.
    10. Sanches, Daniel & Williamson, Stephen, 2010. "Money and credit with limited commitment and theft," Journal of Economic Theory, Elsevier, vol. 145(4), pages 1525-1549, July.
    11. Ivan Werning, 2011. "Managing a Liquidity Trap: Monetary and Fiscal Policy," NBER Working Papers 17344, National Bureau of Economic Research, Inc.
    12. Williamson, Stephen D., 2016. "Scarce collateral, the term premium, and quantitative easing," Journal of Economic Theory, Elsevier, vol. 164(C), pages 136-165.
    13. Lawrence J. Christiano & Martin S. Eichenbaum & Mathias Trabandt, 2015. "Understanding the Great Recession," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 110-167, January.
    14. Michael Woodford, 2012. "Methods of policy accommodation at the interest-rate lower bound," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 185-288.
    15. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
    16. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
    17. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153.
    18. Lawrence Christiano, 2014. "Understanding the Great Recession," Annual Meeting Plenary 2014-1, Society for Economic Dynamics.
    19. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    20. 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.
    21. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    Full references (including those not matched with items on IDEAS)

    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

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    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. repec:eee:dyncon:v:89:y:2018:i:c:p:183-199 is not listed on IDEAS
    5. Williamson, Stephen D., 2015. "Interest on Reserves, Interbank Lending, and Monetary Policy," Working Papers 2015-24, Federal Reserve Bank of St. Louis.
    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, vol. 54(3), pages 922-934, September.
    7. Herrenbrueck, Lucas & Geromichalos, Athanasios, 2017. "A tractable model of indirect asset liquidity," Journal of Economic Theory, Elsevier, vol. 168(C), 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. repec:eee:dyncon:v:89:y:2018:i:c:p:154-172 is not listed on IDEAS
    10. Dong, Feng & Wen, Yi, 2017. "Optimal Monetary Policy under Negative Interest Rate," Working Papers 2017-19, Federal Reserve Bank of St. Louis.
    11. Mathieu Boullot, 2017. "Secular Stagnation, Liquidity Trap and Rational Asset Price Bubbles," Working Papers halshs-01295012, HAL.
    12. Andolfatto, David & Martin, Fernando M., 2018. "Monetary policy and liquid government debt," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 183-199.
    13. Christian Pfister, Natacha Valla, 2018. "‘New Normal’ or ‘New Orthodoxy’? Elements of a Central Banking Framework for the After-Crisis," Working papers 680, Banque de France.

    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

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:moneco:v:73:y:2015:i:c:p:70-92. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/505566 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.