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Some Reflections on the Theory of the “Liquidity Trap”

Palacio Vera, Alfonso (2009) Some Reflections on the Theory of the “Liquidity Trap”. [Working Paper or Technical Report]

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Abstract

We provide a formal definition of the “liquidity trap” (LT) according to which, a LT arises if a combination of high precautionary saving, low investment and stringent conditions for access to bank credit stemming from a high degree of liquidity preference make the sum of the “neutral” interest rate and the expected inflation rate fall short of the term/risk premium on long-term interest rates. We then compare the “New Consensus” (NC) in macroeconomics as expounded in Woodford (2003) and the Post-Keynesian (PK) approach regarding the causes of a LT. We argue that in the NC approach a LT is a phenomenon caused by unusually large transitory shocks that depress the “neutral” interest rate temporarily. By contrast, we argue that in the PK approach an economy may also exhibit a “structural” or long-lasting LT even in the absence of large adverse shocks. Finally, we discuss a number of theoretical issues recently raised in the rapidly growing literature on the LT.

Item Type:Working Paper or Technical Report
Additional Information:JEL Classification: B50, E12, E24, E50
Uncontrolled Keywords:Neutral interest rate, Liquidity trap, Liquidity preference, Credit rationing
Subjects:Social sciences > Economics > Microeconomics
Series Name:Documentos de Trabajo de la Facultad de Ciencias Económicas y Empresariales
Volume:2009
Number:2
ID Code:8586
Deposited On:02 Mar 2009 16:00
Last Modified:06 Feb 2014 08:10

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