Complutense University Library

The "New consensus"and the Post-Keynesian approach to the analysis of liquidity traps


Palacio Vera, Alfonso (2008) The "New consensus"and the Post-Keynesian approach to the analysis of liquidity traps. [ Documentos de Trabajo de la Facultad de Ciencias Económicas y Empresariales; nº 03, 2008, ISSN: 2255-5471 ]

Creative Commons Attribution Non-commercial.


Official URL:


Abstract: We compare the “New Consensus” (NC) in macroeconomics as expounded in Woodford (2003) and the Post-Keynesian (PK) approach regarding the causes of a “liquidity trap” (LT). We argue that in the NC a LT is a phenomenon caused by unusually large transitory shocks that depress the “neutral” interest rate temporarily. We show that this is the case because it is assumed that the “neutral” or “natural” interest rate converges in the long run to a gravitation center whose (positive) lower bound is determined by the rate of time preference of the representative household. By contrast, in the PK approach, the economy may also exhibit a “structural” or long-lasting LT even in the absence of large adverse shocks. This may be the case if a combination of high precautionary saving, low investment spending and stringent conditions for access to bank credit stemming from a high degree of uncertainty and liquidity preference makes the sum of the steady-growth “neutral” interest rate and the inflation rate fall short of the term/risk premium on long-term interest rates.

Item Type:Working Paper or Technical Report
Additional Information:

JEL Classification: B50, E12, E24, E50

Uncontrolled Keywords:Neutral interest rate, Liquidity trap, New Consensus in macroeconomics, Credit rationing and liquidity preference
Subjects:Social sciences > Economics > Macroeconomics
Series Name:Documentos de Trabajo de la Facultad de Ciencias Económicas y Empresariales
ID Code:8453

Arestis, P. & Sawyer, M.C. 2008. A critical reconsideration of the foundations of monetary policy in the new consensus macroeconomic framework, Cambridge Journal of Economics, 32(5), pp. 761-779.

Archibald, J. & Hunter, L. 2001. What is the Neutral Real Interest Rate, and How Can We Use It?, Reserve Bank of New Zealand Bulletin, 64(3), pp. 15-28.

Bernanke, B.S. & Reinhart, V.R. 2004. Conducting Monetary Policy at Very Low Shortterm Interest Rates, American Economic Review, Papers and Proceedings, 94(2), May, pp. 85-90.

Blinder, A.S. 2000. Monetary Policy at the Zero Lower Bound: Balancing the Risks, Journal of Money, Credit and Banking, 32(4), November, pp. 1093-1099.

Carroll, C.D. 1992. The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence, Brookings Papers on Economic Activity, 2, pp. 61-156.

Carroll, C.D. 2001. A Theory of the Consumption Function, With and Without Liquidity Constraints, Journal of Economic Perspectives, 15(3), pp. 23-45.

Carroll, C.D. & Kimball, M.S. 1996. On the Concavity of the Consumption Function, Econometrica, 64(4), pp. 981-992.

Carroll, C.D. & Kimball, M.S. 2001. Liquidity Constraints and Precautionary Saving, NBER Working Paper, no. 8496.

Carroll, C.D. & Samwick, A.A. 1998. How Important is Precautionary Saving?, Review of Economics and Statistics, 80(3), pp. 410-19.

Canzoneri, M. B., Cumby, R. Diba, B. & López-Salido, J.D. 2008. Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework, CEPR, WP-6813, May.

Clarida, R., Galí, J. & Gertler, M. 1999. The Science of Monetary Policy: A New Keynesian Perspective, Journal of Economic Literature, 37, December, pp. 1661-707.

Corrado, C. & Mattey, J. 1997. Capacity Utilization, Journal of Economic Perspectives, 11(1), pp. 151-67.

Cúrdia, V. & Woodford, M. 2008. Credit Frictions and Optimal Monetary Policy, October, mimeo.

Davidson, P. 1991. Is Probability Theory Relevant for Uncertainty?. A Post Keynesian Perspective, Journal of Economic Perspectives, 5(1), pp. 129-43.

Deaton, A. 1991. Saving and Liquidity Constraints, Econometrica, 59(5), pp. 1221-48.

Deaton, A. 1992. Understanding Consumption, Oxford: Oxford University Press.

Dymski, G. A. 1992. A “new view” of the role of banking firms in Keynesian monetary theory, Journal of Post Keynesian Economics, 14(3), pp. 311-320.

Fazzari, S. & Mott, T. L. 1986-87. The investment theories of Kalecki and Keynes: an empirical study of firm data, 1970-1982, Journal of Post Keynesian Economics, 9(2), pp. 171-87.

Fazzari, S. M., Hubbard, R. G., Petersen, B. C., Blinder, A. S. & Poterba, J. M. 1988. Financing constraints and corporate investment, Brookings Papers on Economic Activity, 1, pp. 141–206.

Fazzari, S. & Petersen, B.C. 1993. Working Capital and Fixed Investment: New Evidence on Financing Constraints, Rand Journal of Economics, 24(3), pp. 328-342.

Ferderer, J. P. 1993. Does uncertainty affect investment spending?, Journal of post Keynesian Economics, 16(1), pp. 19-35.

Fisher, I. 1930. The Theory of Interest, New York: Augustus M. Kelley.

Flavin, M.A. 1981. The Adjustment of Consumption to Changing Expectations about Future Income, Journal of Political Economy, 89(5), pp. 974-1009.

Friedman, M.A. 1957. A Theory of the consumption Function, Princeton: Princeton University Press.

Garner, A. 1994. Capacity Utilization and U.S. Inflation, Federal Reserve Bank of Kansas City, Fourth Quarter, pp. 5-21.

Goodhart, C.A.E. 2007. Whatever Became of the Monetary Aggregates?, National Institute Economic Review, April, issue 200, pp. 56-61.

Goodhart, C.A.E. 2008. The Continuing Muddles of Monetary Theory: A Steadfast Refusal to Face Facts, paper presented in the Conference “Macroeconomic Policies on Shaky Foundations ― Whither Mainstream Economics?”, 1st November, Berlin.

Guttentag, J. & Herring, R. 1984. Credit Rationing and Financial Disorder, Journal of Finance, 39(5), pp. 1359-82.

Hall, R.E. 1978. Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence, Journal of Political Economy, 86(6), pp. 971-87.

Hicks, J. 1974. The Crisis in Keynesian Economics, Oxford: Basil Blackwell.

Jappelli, T. & Pagano, M. 1994. Saving, Growth, and Liquidity Constraints, Quarterly Journal of Economics, 109, February, pp. 83-109.

Keynes, J. M. 1930. A Treatise on Money, 2 vols., London: Macmillan.

Keynes, J. M. 1936. The General Theory of Employment, Interest and Money, Cambridge, Macmillan.

Keynes, J. M. 1937. The General Theory of Employment, Quarterly Journal of Economics, 51(2), pp. 209-23.

Kregel, J. 2004. Krugman on the Liquidity Trap: Why Inflation Will not Bring Recovery in Japan, in R. Arena and N. Salvadori (eds.) Money, Credit and the Role of the State: Essays in Honour of Augusto Graziani, pp. 225-38, Aldershot (UK): Ashgate.

Krugman, P. 1998. It’s Baaack: Japan’s Slump and the Return of the Liquidity Trap, Brookings Papers on Economic Activity, 2, pp. 137-205.

Lavoie, M. 1996. Horizontalism, Structuralism, Liquidity Preference and the Principle of Increasing Risk, Scottish Journal of Political Economy, 43(3), August, pp. 275-300.

Leijonhufvud, A. 1973. Effective Demand Failures, Swedish Journal of Economics, 75(1) pp. 27-48.

Leland, H. E. 1968. Saving and Uncertainty: The Precautionary Demand for Saving, Quarterly journal of Economics, 82(3), pp. 465-73.

León-Ledesma, M.A. & Thirlwall, A.P. 2002. The endogeneity of the natural rate of growth, Cambridge Journal of Economics, 26, July, pp. 441-59.

Marglin, S.A. 1984. Growth, Distribution and Prices, Cambridge (MA): Harvard University Press.

Meyer, L.H. 2001. Does Money Matter?, Federal Reserve Bank of St. Louis Review, September/October, pp. 1-15.

Minsky, H.P. 1975. John Maynard Keynes, New York: Columbia University Press.

Modigliani, F. & Cao, L. 2004. The Chinese Saving Puzzle and the Life-Cycle Hypothesis, Journal of Economic Literature, 42(1), pp. 145-170.

Nakatani, T. & Skott, P. 2007. Japanese growth and stagnation: a Keynesian perspective, Structural Change and Economic Dynamics, 18(3), pp. 306-332.

Neal, P. 1996. Keynesian uncertainty in credit markets, Journal of Post Keynesian Economics, 18(3), pp. 397-418.

Palacio-Vera, A. 2005. The ‘modern’ view of macroeconomics: some critical reflections, Cambridge Journal of Economics, 29(4), pp. 747-67.

Palley, T.I. 2008. Keynesian models of deflation and depression revisited, Journal of Economic Behavior and Organization, 68(1), pp. 167-77.

Reifschneider, D. & Williams, J. C. 2000. Three Lessons for Monetary Policy in a LowInflation Era, Journal of Money, Credit and Banking, 32(4), November, pp. 936-966.

Romer, D. 1996. Advanced Macroeconomics, New York: McGraw-Hill.

Runde, J. 1994. Keynesian uncertainty and liquidity preference, Cambridge Journal of Economics, 18(2), pp. 129-44.

Sandmo, A. 1970. The Effect of Uncertainty on Saving Decisions, Review of Economic Studies, 37(3), pp. 353-60.

Samwick, A.A. 1995. The Limited Off-set Between Pension Wealth and the Other Private Wealth: Implications of Buffer-Stock Saving, Manuscript, Department of Economics, Dartmouth College.

Spence, A.M. 1977. Entry, Capacity, Investment and Oligopolistic Pricing, Bell Journal of Economics, 8(2), pp. 534-44.

Stiglitz, J. E. 1988. Money, Credit, and Business Fluctuations, Economic Record, 64, December, pp. 307-22.

Stiglitz, J. E. & Weiss, A. 1981. Credit Rationing in Markets with Imperfect Information, American Economic Review, 71(3), pp. 393-410.

Summers, L. H. 1981. Capital Taxation and Accumulation in a Life Cycle Growth Model, American Economic Review, 71(4), pp. 533-44.

Svensson, L.E.O. 2005. Monetary Policy and Japan´s Liquidity Trap, paper presented at the ESRI International Conference on Policy Options for Sustainable Economic Growth in Japan, Tokyo, September 14, 2005.

Weber, A.A., Lemke, W. and Worms, A. 2008. How useful is the concept of the natural real rate of interest for monetary policy?, Cambridge Journal of Economics, 32(1), pp. 49-63.

Wells, P. 1983. A post Keynesian view of liquidity preference and the demand for money, Journal of Post Keynesian Economics, 5(4), pp. 523-536.

Wicksell, K. 1911. Böhm-Bawerk´s Theory of Capital, in: Erik Lindahl (Ed.) Knut Wicksell-Selected Papers on Economic Theory (London: Allen & Unwin) 1958, pp. 176-85.

Wolfson, M. H. 1996. A Post Keynesian theory of credit rationing, Journal of Post Keynesian Economics, 18(6), pp. 443-70.

Woodford, M. 2003. Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton, NJ, Princeton University Press.

Wray, L.R. 1992. Commercial banks, the central bank, and endogenous money, Journal of Post Keynesian Economics, 14(3), Spring, pp. 297-310.

Deposited On:27 Jan 2009 14:55
Last Modified:01 Dec 2015 09:57

Repository Staff Only: item control page