IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/26277.html
   My bibliography  Save this paper

Liquidity Deflation and Liquidity Trap under Flexible Prices: Some Microfoundations and Implications

Author

Listed:
  • Guillermo A. Calvo

Abstract

The paper discusses simple microfoundations for Liquidity Deflation (Calvo 2016, Chapter 2), which gives rise to liquidity trap under perfectly flexible prices/wages. Unlike Keynes (1936), this is a Supply Side Liquidity Trap, SSLT, not resolved by a fall in prices /wages, or massive helicopter increase in liquid government liabilities. However, escaping SSLT could be achieved by low policy interest rates on money (unless ZLB holds) and, more interestingly, higher inflation driven by administered prices/wages. Moreover, contrary to (Friedman 1969), under Liquidity Deflation the Optimal Quantity of Money does not call for liquidity satiation, and may be dangerously close to SSLT.

Suggested Citation

  • Guillermo A. Calvo, 2019. "Liquidity Deflation and Liquidity Trap under Flexible Prices: Some Microfoundations and Implications," NBER Working Papers 26277, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:26277
    Note: IFM
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w26277.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Jongrim Ha & M. Ayhan Kose & Franziska Ohnsorge, 2019. "Inflation in Emerging and Developing Economies," World Bank Publications - Books, The World Bank Group, number 30657, April.
    2. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2016. "Safe Asset Scarcity and Aggregate Demand," American Economic Review, American Economic Association, vol. 106(5), pages 513-518, May.
    3. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153, Decembrie.
    4. Ha,Jongrim & Kose,Ayhan & Ohnsorge,Franziska Lieselotte, 2019. "Understanding Inflation in Emerging and Developing Economies," Policy Research Working Paper Series 8761, The World Bank.
    5. Guillermo A. Calvo, 2012. "The Price Theory of Money, Prospero's Liquidity Trap, and Sudden Stop: Back to Basics and Back," NBER Working Papers 18285, National Bureau of Economic Research, Inc.
    6. Uribe, Martin, 1997. "Hysteresis in a simple model of currency substitution," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 185-202, September.
    7. Calvo, Guillermo A & Vegh, Carlos A, 1995. "Fighting Inflation with High Interest Rates: The Small Open Economy Case under Flexible Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(1), pages 49-66, February.
    8. Guillermo A. Calvo, 2016. "From Chronic Inflation to Chronic Deflation: Focusing on Expectations and Liquidity Disarray Since WWII," NBER Working Papers 22535, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Justin Damien Guenette & Philip George Kenworthy & Collette Mari Wheeler, 2022. "Implications of the War in Ukraine for the Global Economy," World Bank Publications - Reports 37372, The World Bank Group.
    2. Kose, M. Ayhan & Sugawara, Naotaka & Terrones, Marco E., 2020. "Global Recessions," MPRA Paper 98608, University Library of Munich, Germany.
    3. Cevik Serhan & Jalles Joao, 2024. "Eye of the Storm: The Impact of Climate Shocks on Inflation and Growth," Review of Economics, De Gruyter, vol. 75(2), pages 109-138.
    4. Sitikantha Pattanaik & Silu Muduli & Soumyajit Ray, 2020. "Inflation expectations of households: do they influence wage-price dynamics in India?," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 13(3), pages 244-263, September.
    5. Szafranek, Karol, 2021. "Disentangling the sources of inflation synchronization. Evidence from a large panel dataset," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 229-245.
    6. Ryan Niladri Banerjee & Valerie Boctor & Aaron Mehrotra & Fabrizio Zampolli, 2023. "Fiscal sources of inflation risk in EMDEs: the role of the external channel," BIS Working Papers 1110, Bank for International Settlements.
    7. Philipp F. M. Baumann & Enzo Rossi & Alexander Volkmann, 2020. "What Drives Inflation and How: Evidence from Additive Mixed Models Selected by cAIC," Papers 2006.06274, arXiv.org, revised Aug 2022.
    8. World Bank, 2022. "Maximizing Finance for Development," World Bank Publications - Reports 37100, The World Bank Group.
    9. Gomez-Gonzalez, Jose Eduardo & Hirs-Garzon, Jorge & Uribe, Jorge M., 2020. "Global effects of US uncertainty: real and financial shocks on real and financial markets," Working papers 69, Red Investigadores de Economía.
    10. Serhan Cevik & Tianle Zhu, 2020. "Trinity Strikes Back: Monetary Independence And Inflation In The Caribbean," Journal of International Development, John Wiley & Sons, Ltd., vol. 32(3), pages 375-388, April.
    11. Vybhavi Balasundharam & Olivier Basdevant & Dalmacio Benicio & Andrew Ceber & Yujin Kim & Luca Mazzone & Hoda Selim & Yongzheng Yang, 2023. "Fiscal Consolidation: Taking Stock of Success Factors, Impact, and Design," IMF Working Papers 2023/063, International Monetary Fund.
    12. M. Ayhan Kose & Peter S. O. Nagle & Franziska Ohnsorge & Naotaka Sugawara, 2020. "Can This Time Be Different? Policy Options in Times of Rising Debt," Koç University-TUSIAD Economic Research Forum Working Papers 2008, Koc University-TUSIAD Economic Research Forum.
    13. Guillermo A. Calvo, 2012. "The Price Theory of Money, Prospero's Liquidity Trap, and Sudden Stop: Back to Basics and Back," NBER Working Papers 18285, National Bureau of Economic Research, Inc.
    14. Jongrim Ha & M. Ayhan Kose & Franziska Ohnsorge, 2021. "Inflation During the Pandemic: What Happened? What is Next?," Koç University-TUSIAD Economic Research Forum Working Papers 2108, Koc University-TUSIAD Economic Research Forum.
    15. Ha, Jongrim & Kose, M. Ayhan & Ohnsorge, Franziska, 2023. "One-stop source: A global database of inflation," Journal of International Money and Finance, Elsevier, vol. 137(C).
    16. Tommy Chrimes & Bram Gootjes & M. Ayhan Kose & Collette Wheeler, 2024. "The Great Reversal," World Bank Publications - Books, The World Bank Group, number 41403, April.
    17. Kristin Forbes & Jongrim Ha & M. Ayhan Kose, 2025. "Tradeoffs over Rate Cycles: Activity, Inflation, and the Price Level," NBER Chapters, in: NBER Macroeconomics Annual 2025, volume 40, National Bureau of Economic Research, Inc.
    18. Douglas Gale & Tanju Yorulmazer, 2020. "Bank capital, fire sales, and the social value of deposits," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(4), pages 919-963, June.
    19. Eric Monnet & Mr. Damien Puy, 2019. "One Ring to Rule Them All? New Evidence on World Cycles," IMF Working Papers 2019/202, International Monetary Fund.
    20. World Bank, 2022. "Global Economic Prospects, January 2022," World Bank Publications - Books, The World Bank Group, number 36519, April.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:nbr:nberwo:26277. See general information about how to correct material in RePEc.

    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 bibliographic 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.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.