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Liquidity Trap Prevention and Escape: A Simple Proposition

  • Junning Cai

Liquidity traps occur when the natural nominal interest rate becomes negative. In a model with capital price dynamics explicitly considered, we find that shocks in the future can cause current and lasting liquidity traps. We propose that the central bank can prevent or fix liquidity traps by appending to its inflation-targeting monetary policy with a prioritized promise to defend a lower bound of nominal capital price. (JEL E31, E43, E44, E52, E58, E61, G12) Keywords: Liquidity traps; Zero interest bound; Asset Prices; Lower capital price bound

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File URL: http://econwpa.repec.org/eps/mac/papers/0402/0402033.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0402033.

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Date of creation: 29 Feb 2004
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Handle: RePEc:wpa:wuwpma:0402033
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  1. Auerbach, Alan J. & Obstfeld, Maurice, 2004. "The Case for Open-Market Purchases in a Liquidity Trap," Center for International and Development Economics Research, Working Paper Series qt1dn4d9sr, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  2. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1999. "Avoiding Liquidity Traps," Working Papers 99-21, C.V. Starr Center for Applied Economics, New York University.
  3. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
  4. Adam, Klaus & Billi, Roberto M, 2003. "Optimal Monetary Policy Under Commitment with a Zero Bound on Nominal Interest Rates," CEPR Discussion Papers 4111, C.E.P.R. Discussion Papers.
  5. Alexander L. Wolman, 2003. "Real implications of the zero bound on nominal interest rates," Working Paper 03-15, Federal Reserve Bank of Richmond.
  6. Coenen, Guenter & Wieland, Volker, 2003. "The Zero-Interest-Rate and the Role of the Exchange Rate for Monetary Policy in Japan," CFS Working Paper Series 2003/09, Center for Financial Studies (CFS).
  7. 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.
  8. Ben S. Bernanke & Vincent R. Reinhart, 2004. "Conducting Monetary Policy at Very Low Short-Term Interest Rates," American Economic Review, American Economic Association, vol. 94(2), pages 85-90, May.
  9. Clouse James & Henderson Dale & Orphanides Athanasios & Small David H. & Tinsley P.A., 2003. "Monetary Policy When the Nominal Short-Term Interest Rate is Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-65, September.
  10. Bryant, Ralph C, 2000. "Comment on Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1036-50, November.
  11. McCallum, Bennett T, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 870-904, November.
  12. Junning Cai, 2003. "Fundamental Paper Wealth and Monetary Policy," Macroeconomics 0309001, EconWPA.
  13. Buiter, Willem H., 2003. "Deflation: Prevention and Cure," CEPR Discussion Papers 3869, C.E.P.R. Discussion Papers.
  14. Volker Wieland & Gunter Coenen, 2003. "The Zero-Interest-Rate Bound and the Role of the Exchange Rate for Monetary Policy in Japan," Computing in Economics and Finance 2003 138, Society for Computational Economics.
  15. Freedman, Charles, 2000. "Comment on Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1051-57, November.
  16. 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.
  17. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  18. Wallace, Neil, 2000. "Comment on Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 931-35, November.
  19. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," NBER Working Papers 10195, National Bureau of Economic Research, Inc.
  20. Christiano, Lawrence J, 2000. "Comment on Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 905-30, November.
  21. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap; Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  22. Willem H. Buiter, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency : Gesell's solution," LSE Research Online Documents on Economics 848, London School of Economics and Political Science, LSE Library.
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