Liquidity and growth traps: a framework for the analysis of macroeconomic policy in the 'age' of Central Banks

Alfonso Palacio Vera
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Alfonso Palacio Vera: Departamento de Economía Aplicada, Pública y Política. Universidad Complutense de Madrid., https://www.ucm.es/eapp

No 05-02, Documentos de trabajo de la Facultad de Ciencias Económicas y Empresariales from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales

Abstract: Conventional explanations of how a growing potential output generates an equi-proportional increase in aggregate demand in the long run usually rely on the real balance effect. Yet this mechanism has a negligible size and an uncertain sign. We present a theoretical framework for the analysis of the power of conventional monetary policy to take the economy down its potential output path. We develop a simple model that predicts the behavior of the ‘neutral’ interest rate and the ‘pseudo-warranted’ interest rate in the wake of different types of shocks. We identify several different scenarios according to whether the behavior of the ‘neutral’ real interest rate enhances or weakens the power of conventional monetary policy. Likewise, we identify several regimes depending on whether a rise in the target rate of inflation in steady growth yields faster or slower output growth when the ‘natural’ rate is not (fully) exogenous. In addition, we provide a formal definition of the concept of the ‘growth trap’ which complements the notion of the ‘liquidity trap’. Finally, we propose a taxonomy of monetary policy regimes.

Keywords: Bancos centrales; Política macroeconómica; Neutral and warranted real interest rate; Liquidity trap; Growth trap; Inflation; Monetary policy. (search for similar items in EconPapers)
JEL-codes: E31 E49 E59 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2005
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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