Liquidity Deflation and Liquidity Trap under Flexible Prices: Some Microfoundations and Implications

Guillermo Calvo

No 26277, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The paper discusses simple microfoundations for Liquidity Deflation (Calvo 2016, Chapter 2), which gives rise to liquidity trap under perfectly flexible prices/wages. Unlike Keynes (1936), this is a Supply Side Liquidity Trap, SSLT, not resolved by a fall in prices /wages, or massive helicopter increase in liquid government liabilities. However, escaping SSLT could be achieved by low policy interest rates on money (unless ZLB holds) and, more interestingly, higher inflation driven by administered prices/wages. Moreover, contrary to (Friedman 1969), under Liquidity Deflation the Optimal Quantity of Money does not call for liquidity satiation, and may be dangerously close to SSLT.

JEL-codes: E31 E4 E41 E5 E52 (search for similar items in EconPapers)
Date: 2019-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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