Discussion paper

DP11369 Money and Capital in a Persistent Liquidity Trap

In this paper we analyze the implications of a persistent liquidity trap in a monetary model with asset scarcity and price flexibility. We show that a liquidity trap leads to an increase in cash holdings and may be associated with a long-term output decline. This long-term impact is a supply-side effect that may arise when agents are heterogeneous. It occurs in particular with a persistent deleveraging shock, leading investors to hold cash yielding a low return. Policy implications differ from shorter-run analyses. Quantitative easing leads to a deeper liquidity trap. Exiting the trap by increasing expected inflation or applying negative interest rates does not solve the asset scarcity problem.

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Citation

Benhima, K, P Bacchetta and Y Kalantzis (eds) (2016), “DP11369 Money and Capital in a Persistent Liquidity Trap”, CEPR Press Discussion Paper No. 11369. https://new.cepr.org/publications/dp11369