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A Neoclassical Theory of Liquidity Traps

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  • Sebastian Di Tella

    (Stanford GSB)

Abstract

This paper provides an equilibrium theory of liquidity traps and the real effects of money. Money provides a safe store of value that prevents interest rates from falling enough during downturns, and the economy enters a persistent slump with depressed investment. This is an equilibrium outcome—prices are flexible, markets clear, and inflation is on target—but it’s not efficient. Investment is too high during booms and too low during liquidity traps. Although money has large real effects, monetary policy is ineffective—the zero lower bound is not binding, money is superneutral, and Ricardian equivalence holds. The optimal allocation requires the Friedman rule and a tax/subsidy on capital.

Suggested Citation

  • Sebastian Di Tella, 2018. "A Neoclassical Theory of Liquidity Traps," 2018 Meeting Papers 96, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:96
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    Cited by:

    1. Maruyama, Yuuki, 2020. "A Model of Monetary Transmission Mechanism," SocArXiv hm9jn, Center for Open Science.
    2. Bacchetta, Philippe & Benhima, Kenza & Kalantzis, Yannick, 2020. "Money and capital in a persistent liquidity trap," Journal of Monetary Economics, Elsevier, vol. 116(C), pages 70-87.
    3. Vladimir Asriyan & Luca Fornaro & Alberto Martin & Jaume Ventura, 2021. "Monetary Policy for a Bubbly World [Money and Capital in a Persistent Liquidity Trap]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(3), pages 1418-1456.
    4. Maruyama, Yuuki, 2020. "Monopolistic Competition, Precautionary Savings, Coordination Failure," SocArXiv t836n, Center for Open Science.

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