Financial Crashes versus liquidity trap: the dilemma of monetary policy
This paper considers a two-period monetary double auction with incomplete markets of securities and derivatives. Players may share heterogenous beliefs. Short positions in derivatives are constrained by collateral requirements. A central Bank stands ready to lend money or engage in unconventional monetary policy such as quantitative easing. In sharp contrast with the usual picture of equilibrium properties, I show that only three scenarios are compatible with Nash equilibrium condition: 1) either the economy enters a liquidity trap in the first period; 2) or the money injected by the Central Bank fuels a financial inflation driven by "rational exuberance", whose burst leads to a global crash in the next period, 3) else a significant inflation of commodity prices accompanies the functioning of markets. In particular, neither Friedman's golden rule, nor the Taylor rule turn out to be compatible with the third scenario: Both inevitable lead to a liquidity trap. An example shows that quantitative easing does not provide, in general, any escape from the monetary dilemma
|Date of creation:||Feb 2010|
|Date of revision:|
|Contact details of provider:|| Postal: 106-112 boulevard de l'Hôpital 75 647 PARIS CEDEX 13|
Phone: + 33 44 07 81 00
Fax: + 33 1 44 07 83 01
Web page: http://centredeconomiesorbonne.univ-paris1.fr/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- William R. Zame, 1990.
"Efficiency and the Role of Default When Security Markets are Incomplete,"
UCLA Economics Working Papers
585, UCLA Department of Economics.
- Zame, William R, 1993. "Efficiency and the Role of Default When Security Markets Are Incomplete," American Economic Review, American Economic Association, vol. 83(5), pages 1142-64, December.
- William R. Zame, 1992. "Efficiency and the Role of Default When Security Markets are Incomplete," UCLA Economics Working Papers 673, UCLA Department of Economics.
- Gaël Giraud, 2004. "The limit-price exchange process," Cahiers de la Maison des Sciences Economiques b04118, Université Panthéon-Sorbonne (Paris 1).
- Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010.
"Rethinking Macroeconomic Policy,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 42(s1), pages 199-215, 09.
- Giraud, Gael, 2003. "Strategic market games: an introduction," Journal of Mathematical Economics, Elsevier, vol. 39(5-6), pages 355-375, July.
- Karl Schmedders, Felix Kubler, 2001. "Asset Pricing in Models with incomplete markets and default," Computing in Economics and Finance 2001 58, Society for Computational Economics.
- John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-44, September.
- Araújo, Aloísio & Kubler, Felix & Schommer, Susan, 2012. "Regulating collateral-requirements when markets are incomplete," Journal of Economic Theory, Elsevier, vol. 147(2), pages 450-476.
When requesting a correction, please mention this item's handle: RePEc:mse:cesdoc:10014. 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: (Lucie Label)
If references are entirely missing, you can add them using this form.