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Liquidity traps and large-scale financial crises

Author

Listed:
  • Giovanni Caggiano

    (Department of Economics - Monash University [Clayton], Department of Economics and Management - Unipd - Università degli Studi di Padova = University of Padua)

  • Efrem Castelnuovo

    (Department of Economics and Management - Unipd - Università degli Studi di Padova = University of Padua, Melbourne Institute of Applied Economic and Social Research, Departement of Economics [Melbourne] - Faculty of Business and Economics [Melbourne] - University of Melbourne)

  • Olivier Damette

    (BETA - Bureau d'Économie Théorique et Appliquée - INRA - Institut National de la Recherche Agronomique - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique)

  • Antoine Parent

    (IEP Lyon - Sciences Po Lyon - Institut d'études politiques de Lyon - Université de Lyon, LAET - Laboratoire Aménagement Économie Transports - UL2 - Université Lumière - Lyon 2 - ENTPE - École Nationale des Travaux Publics de l'État - CNRS - Centre National de la Recherche Scientifique)

  • Giovanni Pellegrino

    (Melbourne Institute of Applied Economic and Social Research, Departement of Economics [Melbourne] - Faculty of Business and Economics [Melbourne] - University of Melbourne)

Abstract

This paper estimates a nonlinear Threshold-VAR to investigate if a Keynesian liquidity trap due to a speculative motive was in place in the U.S. Great Depression and the recent Great Recession. We find clear evidence in favor of a breakdown of the liquidity effect after an unexpected increase in M2 in the 1921–1940 period. This evidence, which is consistent with the Keynesian view on a liquidity trap, is shown to be state contingent. In particular, it emerges only when a speculative regime identified by high realizations of the Dow Jones index is considered. A standard linear framework is shown to be ill-suited to test the hypothesis of a Keynesian liquidity trap. An investigation performed with the same data for the period 1991–2010 confirms the presence of a liquidity trap just in the speculative regime. This last result emerges significantly only when we consider the federal funds rate as the policy instrument and we model the Divisia M2 measure of liquidity.

Suggested Citation

  • Giovanni Caggiano & Efrem Castelnuovo & Olivier Damette & Antoine Parent & Giovanni Pellegrino, 2017. "Liquidity traps and large-scale financial crises," Post-Print halshs-01675562, HAL.
    • Handle: RePEc:hal:journl:halshs-01675562
    DOI: 10.1016/j.jedc.2017.03.001
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    Cited by:

    1. Le Riche, Antoine & Magris, Francesco & Parent, Antoine, 2017. "Liquidity Trap and stability of Taylor rules," Mathematical Social Sciences, Elsevier, vol. 88(C), pages 16-27.

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    JEL classification:

    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • N12 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - U.S.; Canada: 1913-
    • N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-

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