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Optimal Monetary Policy in a Liquidity Trap with Heterogeneous Agents

Xavier Ragot ()

No 2017-05, Sciences Po Economics Discussion Papers from Sciences Po Departement of Economics

Abstract: This paper derives the optimal money injection at the Zero Lower Bound (ZLB), in a tractable model where households hold heterogeneous money holdings due to explicit financial frictions, such as limited participation or temporary binding credit constraints. This framework is motivated by recent empirical findings. A deleveraging shock generates deflationary pressure and a fall in the real interest rate, pushing the economy to the ZLB. The main result is that open-market operations can stabilize the economy at the ZLB whereas lump-sum money transfers cannot. Moreover, an optimal money injection does not avoid the economy being at the ZLB.

Keywords: Liquidity trap; Zero lower bound; Heterogeneous agents; Optimal policy (search for similar items in EconPapers)
JEL-codes: E41 E52 E32 (search for similar items in EconPapers)
Date: 2017
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