Unemployment risk, liquidity traps and monetary policy

Dario Bonciani and Joonseok Oh

No 920, Bank of England working papers from Bank of England

Abstract: When the economy is in a liquidity trap and households have a precautionary motive to save against unemployment risk, adverse demand shocks cause severe deflationary spirals and output contractions. In this context, we study the implications of optimal monetary policy, which consists of keeping the nominal rate at zero longer than implied by current macroeconomic conditions. Under such policy and incomplete markets, expected improvements in labour market conditions mitigate the rise in unemployment risk and decline in demand. As a result, market incompleteness may alleviate contractions in output and inflation during a liquidity trap. However, reducing market incompleteness mitigates the fall in demand under realistic monetary policy rules.

Keywords: Unemployment risk; Liquidity trap; Zero lower bound; Monetary policy (search for similar items in EconPapers)
JEL-codes: E21 E24 E32 E52 E61 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2021-05-14
New Economics Papers: this item is included in nep-cba, nep-cwa, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0920

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