The Macroeconomics of Financial Crises: How Risk Premiums and Liquidity Traps Affect Policy Options

Manfred Gärtner () and Florian Jung

International Advances in Economic Research, 2011, vol. 17, issue 1, 12-27

Abstract: The paper offers an overview of what structural models of the IS-LM and Mundell-Fleming variety can tell about the macroeconomics of economic crises. In addition to demonstrating how the emergence of risk premiums in money and capital markets can generate liquidity traps at positive interest rates and may drive economies into recessions, it shows the following: (1) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (2) Near the fringe of liquidity traps, there may be perfect traps, in which neither monetary nor fiscal policy works when used in isolation but policy coordination is called for; and (3) Massive financial crises in the domestic money market may even destabilize the economy. Copyright International Atlantic Economic Society 2011

Keywords: Financial crisis; Credit crunch; Liquidity trap; Risk premiums; Policy options; Fiscal policy; Monetary policy; A20; E63; F01 (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1007/s11294-010-9290-z

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