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Liquidity Trap and stability of Taylor rules

Antoine Le Riche, Francesco Magris and Antoine Parent
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Antoine Parent: LAET - Laboratoire Aménagement Économie Transports - UL2 - Université Lumière - Lyon 2 - ENTPE - École Nationale des Travaux Publics de l'État - CNRS - Centre National de la Recherche Scientifique, IEP Lyon - Sciences Po Lyon - Institut d'études politiques de Lyon - Université de Lyon, IXXI - Institut Rhône-Alpin des systèmes complexes - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UJML - Université Jean Moulin - Lyon 3 - Université de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - INSA Lyon - Institut National des Sciences Appliquées de Lyon - Université de Lyon - INSA - Institut National des Sciences Appliquées - Inria - Institut National de Recherche en Informatique et en Automatique - CNRS - Centre National de la Recherche Scientifique - UGA [2016-2019] - Université Grenoble Alpes [2016-2019]

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Abstract: We study a productive economy with fractional cash-in-advance constraint on consumption expenditures. Government issues safe bonds and levies taxes to finance public expenditures, while the Central Bank follows a feedback Taylor rules by pegging the nominal interest rate. We show that when the nominal interest rate is bound to be non-negative, under active policy rules a Liquidity Trap steady state does emerge besides the Leeper (1991) equilibrium. The stability of the two steady states depends, in turn, upon the amplitude of the liquidity constraint. When the share of consumption to be paid cash is set lower than one half, the Liquidity Trap equilibrium is indeterminate. The stability of the Leeper equilibrium too depends dramatically upon the amplitude of the liquidity constraint: for low amplitudes of the latter, the Leeper equilibrium can be indeed stable. Policy and Taylor rules are thus theoretically rehabilitated since their targets, by contrast with a vast literature, may be reached for infinitely many agents' beliefs. We also show that a relaxation of the liquidity constraint is Pareto-improving and that the Liquidity Trap equilibrium Pareto-dominates the Leeper one, in view of the zero cost of money.

Keywords: Cash-in-Advance; Liquidity Trap; Monetary Policy; Multiple Equilibria (search for similar items in EconPapers)
Date: 2017-07
Note: View the original document on HAL open archive server: https://hal-univ-orleans.archives-ouvertes.fr/hal-03554315
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Published in Mathematical Social Sciences, Elsevier, 2017, 88 (C), pp.16-27. ⟨10.1016/j.mathsocsci.2017.04.003⟩

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Journal Article: Liquidity Trap and stability of Taylor rules (2017) Downloads
Working Paper: Liquidity Trap and Stability of Taylor Rules (2016) Downloads
Working Paper: Liquidity Trap and Stability of Taylor Rules (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03554315

DOI: 10.1016/j.mathsocsci.2017.04.003

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