A Neoclassical Theory of Liquidity Traps

Sebastian Di Tella
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Sebastian Di Tella: Stanford GSB

No 96, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper provides an equilibrium theory of liquidity traps and the real effects of money. Money provides a safe store of value that prevents interest rates from falling enough during downturns, and the economy enters a persistent slump with depressed investment. This is an equilibrium outcome—prices are flexible, markets clear, and inflation is on target—but it’s not efficient. Investment is too high during booms and too low during liquidity traps. Although money has large real effects, monetary policy is ineffective—the zero lower bound is not binding, money is superneutral, and Ricardian equivalence holds. The optimal allocation requires the Friedman rule and a tax/subsidy on capital.

Date: 2018
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:96

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