Abstract
This article addresses the low inflation rates of recent years in the light of expansionary monetary policy. Building on essential macroeconomic relationships we present a modern version of the quantity theory of money. At low rates of inflation, an expansionary monetary policy can induce an increase in the money stock not matched by a corresponding increase in prices. When money demand is very elastic – a liquidity trap effect – real money balances can increase by 100 percent or more. The key to this phenomenon is the insight that a peg of the policy interest rate at a very low level does not lead to accelerating inflation.
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