Debt-Deflation versus the Liquidity Trap: The Dilemma of Nonconventional Monetary Policy

Gaël Giraud and Antonin Pottier

Documents de travail du Centre d'Economie de la Sorbonne from Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne

Abstract: This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, endogenously incomplete markets of financial securities, durable goods and production. Short positions in financial assets and long-term loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to the loan. We show that Collateral Monetary Equilibria exist and prove there is also a refinement of the Quantity Theory of Money that turns out to be compatible with the long-run non-neutrality of money. Moreover, only three scenarios are compatible with the equilibrium condition: 1) either the economy enters a liquidity trap in the first period; 2) or a credible ex-pansionary monetary policy accompanies the orderly functioning of markets at the cost of running an inflationary risk; 3) else the money injected by the Central Bank increases the leverage of indebted investors, fueling a financial bubble whose bursting leads to debt-deflation in the next period with a non-zero probability. This dilemma of monetary policy highlights the default channel affecting trades and production, and provides a rigorous foundation to Fisher’s debt deflation theory as being distinct from Keynes’ liquidity trap

Keywords: Central Bank; liquidity trap; collateral; default; deflation; quantitative easing; debt-deflation (search for similar items in EconPapers)
JEL-codes: D50 E40 E44 E50 E52 E58 G38 H50 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2012-10
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://mse.univ-paris1.fr/pub/mse/CES2012/12064.pdf (application/pdf)

Related works:
Journal Article: Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy (2016)
Working Paper: Debt-deflation versus liquidity trap: the dilemma of nonconventional monetary policy (2016)
Working Paper: Debt-Deflation versus the Liquidity Trap: the Dilemma of Nonconventional Monetary Policy (2012)
Working Paper: Debt-Deflation versus the Liquidity Trap: the Dilemma of Nonconventional Monetary Policy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:mse:cesdoc:12064

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