The macroeconomics of financial crises: How risk premiums, liquidity traps and perfect traps affect policy options

Manfred Gärtner () and Florian Jung

University of St. Gallen Department of Economics working paper series 2009 from Department of Economics, University of St. Gallen

Abstract: The paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only when interest rates approach zero but at positive and/or rising rates as well; (2) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (3) Near the fringe of liquidity traps, the risk arises of perfect traps, in which neither monetary nor fiscal policy works when used in isolation, but policy coordination is called for; and (4) Massive financial crises in the domestic money market may even destabilize the economy.

Keywords: financial crisis; credit crunch; liquidity trap; zero lower bound; risk premiums; policy options; fiscal policy; monetary policy; open economy. (search for similar items in EconPapers)
JEL-codes: E63 F01 F41 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2009-07
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:usg:dp2009:2009-15

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