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Monetary policy in a liquidity trap

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  • Michael Dotsey

Abstract

In the United States, the Federal Reserve sets monetary policy by targeting the federal funds rate. This process usually involves lowering short-term interest rates when economic growth is weak and raising them when economic growth is strong. A wide class of economic models has shown that, in theory, conducting policy in this way allows the economy to employ resources efficiently. In addition, many empirical studies have shown that most central banks actually behave in this manner. In normal times, it is fairly easy for the central bank to conduct policy in this fashion. But there is one instance when conducting policy in this manner becomes problematic: when the economy finds itself in a \\"liquidity trap,\\" a situation in which the short-term nominal interest rate is zero or very close to zero. In \\"Monetary Policy in a Liquidity Trap,\\" Mike Dotsey analyzes the difficulties a central bank faces in such circumstances and discusses the tools available to monetary policymakers. Policy as usual is not an option, and the central bank's framework for conducting policy must change.

Suggested Citation

  • Michael Dotsey, 2010. "Monetary policy in a liquidity trap," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 9-15.
    • Handle: RePEc:fip:fedpbr:y:2010:i:q2:p:9-15
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    References listed on IDEAS

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    1. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    2. Charles I. Plosser, 2009. "The economic outlook and some challenges facing the Federal Reserve: a speech at the Economic Outlook Panel, University of Delaware, January 14, 2009," Speech 23, Federal Reserve Bank of Philadelphia.
    3. Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February.
    4. Alexander L. Wolman, 1998. "Staggered price setting and the zero bound on nominal interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-24.
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    Cited by:

    1. M. Kasongo Kashama, 2016. "Helicopter money and debt-financed fiscal stimulus : one and the same thing ?," Economic Review, National Bank of Belgium, issue iii, pages 31-40, December.

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