Liquidity Trap Research Articles

Optimal Monetary and Transfer Policy in a Liquidity Trap

AbstractOptimal monetary and fiscal policy are jointly analyzed in a heterogeneous two‐agent New Keynesian environment, where fiscal policy is modeled as lump‐sum transfers. Transfer policy does not substitute for forward guidance—as it entails consumption dispersion costs—nor affect its optimal duration. The stay at the zero lower bound is indeed influenced through two offsetting channels: a shortening channel works through an initial increase in transfers that mitigates the recession (reducing the need for forward guidance), while a lengthening channel works through a later transfer cut that curbs the expansion (making forward guidance desirable for a longer horizon).

Monetary policy rules and zero lower bound on nominal interest rates in a cost-channel economy

This study analyzed monetary policy rules in a cost-channel economy with a zero lower bound on nominal interest rates (ZLB). The cost channel reflects the supply-side effects of the monetary policy. The ZLB is considered an occasionally binding constraint in a new Keynesian setting. Taylor-type interest rules represent the monetary policy rules, and the novel forward guidance rule introduced in this study is anticipated and endogenous. Under monetary policy rules, a cost-channel economy is more likely to fall into a liquidity trap and remain there longer than a no-cost-channel economy. Accordingly, monetary policy transmission differs from that in a no-cost-channel economy in the ZLB presence. Furthermore, if agents expect future recessions, achieving the inflation target is more challenging in cost-channel economies. Irrespective of the existence of a cost channel, the forward guidance rule reduces the frequency and depth of liquidity-trapped recessions compared to the Taylor-type rules and avoids deflation bias.

Testing and mechanism identification of liquidity trap in China

ABSTRACT This paper examines the existence and mechanism of China’s liquidity trap. First, a broad money supply model is reconstructed to evaluate the effectiveness of monetary policy. Based on the observed data from 1997 to 2022 and first-order difference regression results, we find that: The relationship between the monetary base and broad money exhibits two distinct stages, with 2008 as a delineating point. Pre-2008, the money creation multiplier is significant; post-2008, it becomes insignificant. Second, by examining the asset-side and liability-side gaps of the financial system, we have identified two liquidity traps. The first occurs between 2015 and 2019, caused by funds idling within the financial system. The second occurs in 2020- and is caused by recessionary expectations. Monetary policy flexibility is waning, compelling strategic decisions for Chinese government and central bank.

Optimal robust monetary and fiscal policy under uncertainty on the lower bound

This paper studies robust policy when the policymaker has Knightian uncertainty about the exact position of the effective lower bound (ELB). First, we characterize optimal discretionary policy when a benevolent policymaker controls the nominal interest rate and the level of government spending. Compared to the full information case, an uncertainty-averse policymaker overestimates the level of the ELB, thereby triggering a more aggressive reduction in the nominal interest rate prior to the liquidity trap. Furthermore, the anticipation of a larger increase in public spending improves the trade-off between inflation and the output gap, and dampens the perceived worst-case level of the ELB. As a result, a less conservative fiscal stabilization is desirable to address the uncertainty concerns of the policymaker by partially substituting for the nominal interest rate at the ELB. Moreover, an inflation-conservative policymaker mitigates the impact of uncertainty on equilibrium outcomes even better than a fiscally active policymaker.

Money growth pegging, Taylor rule, status‐seeking behavior and the “spirit of capitalism”

AbstractThis paper analyzes the impact of “spirit of capitalism” on stationary welfare and stability properties of a one‐sector Ramsey economy, where the demand of money is motivated by a cash‐in‐advance constraint on consumption expenditures. Preferences are defined over consumption and capital stock. There is a monetary authority that follows either a money growth pegging rule or an interest rate pegging rule. When a money growth pegging rule is introduced, a unique steady state emerges. A slight desire for status is a sufficient condition for an increase in the money growth rate to exert a local stabilizing effect and to improve stationary welfare. When an interest rate pegging rule is introduced, two steady states may emerge: a “liquidity trap” and an “interior” steady state. Both steady states are locally determinate. Moreover, we show that a slight desire for status is also a sufficient condition to ensure that the stationary welfare at “interior” steady state is higher than the one of the “liquidity trap”. It follows that an increase in the policy rate is, then, an efficient way to exit the “liquidity trap” steady state. Under similar conditions, a higher policy rate increases the stationary welfare at the “interior” steady state.

Risk-averse corporate investment behavior and the effectiveness of quantitative easing

This paper analyzes how risk-averse investment behavior in a liquidity trap can render quantitative easing ineffective under certain circumstances. For risk-averse firms that could lever either a risky investment project or a riskless alternative, I show that the real interest rate responsiveness of a relative net investment return causes both the interest-rate sensitivity of investment and the slope of the aggregate demand (AD) curve to bifurcate. Except for the scenario of sufficiently low investment return and high real interest rates, investment is positively related to real interest rates and the AD curve is downward sloping; under the circumstances, quantitative easing backfires but laissez faire helps stimulate investment instead.

Quantitative Easing’s Effects on the U.S. Housing Market

As the housing bubble burst in the United States, the buildup of subprime lending led to the Global Financial Crisis. The Federal Reserve desperately slashes interest rates to reverse the economic recession, but the Zero Lower Bound significantly hindered the policy's future effectiveness with concerns of an existing liquidity trap. As a result, the unprecedented Quantitative Easing became the policymakers' last resort. Through the large-scale purchases of financial assets including mortgage-backed securities (MBS) and government bonds, the Fed attempts to stimulate the economy through reserve creation and instilling downward pressure on future interest rates. This literature review discusses how QE specifically affected the U.S. housing market during the GFC. An analysis is conducted on various social aspects and stakeholders by identifying the various channels through which QE is transmitted. The signaling, bank lending, and refinancing channels all suggest that MBS had the greatest effect on market expectations, bank behaviors, and consumer spending. As a result, many were many spillover effects into real estate, notably on asset prices, employment, and investment. Even though literature has criticized QE's ineffectiveness and its potential drawbacks, the unconventional monetary policy certainly played an essential role in preventing a worse outcome and effectively demonstrating its ability to reduce interest rates, generate wealth, and revive the economy.

Fiscal stimulus: A comprehensive bibliometric analysis

This study fills the void because no specific research on fiscal stimulus using bibliometric analysis in the last decade has been conducted. This study aims to identify trends in fiscal stimulus that can be useful as a decision-making support tool in setting future research priorities (Mejia et al., 2021). This research method adopts Garza and Reyes’s (2015) five-step bibliometric analysis phase: determining search keywords, initializing search results, refining search results, compiling initial data statistics, and analyzing data. Based on the research results, at the initial results stage, 779 datasets were obtained from the Scopus database, reduced to produce 578 data and visualized using VOSviewer. This study lists research trends, active journal publishers, prolific writers, the most active nations and institutions and the most important scientific fields. Based on the distinctive relationships of groups of keywords within clusters, cluster analysis identifies the primary study subjects in fiscal stimulus. The authors conclude that the research areas based on keyword analysis that rarely occur as future study topics related to fiscal stimulus are climate change, multiplier, lockdown and H30 (fiscal policy and behavior of general economic actors), and the liquidity trap.

Liquidity Traps in Hotel Revenue Management during the Pandemic and Actions Taken by Hoteliers

Liquidity Traps in Hotel Revenue Management during the Pandemic and Actions Taken by Hoteliers

Stock market response to public investment under the zero lower bound: Cross-industry evidence from Japan

This study examines the effects of public investment on the stock market between the zero lower bound (ZLB) and the non-ZLB periods using Japanese sectoral panel data. The empirical results first show that while public investment shocks have stimulating effects on stock returns during the ZLB period, this is not the case outside of the ZLB. Furthermore, the impulse responses for the manufacturing industry are estimated to be positive and significant regardless of model specification. Our results suggest that the government is recommended to increase public investment under the ZLB to prop up the stock market but cut back once the economy is no longer in a liquidity trap.

The costs of macroprudential deleveraging in a liquidity trap

We study various macroprudential tools and their interaction with monetary policy in a New Keynesian model featuring long-term debt, illiquid housing and an effective lower bound constraint on policy rates. We find that the short-run deleveraging costs of different macroprudential tools – all sized to imply the same reduction in household debt in the medium and long-term – can differ significantly, depending on the state of economy and monetary policy. Specifically, a loan-to-value tightening is more than three times as contractionary as a loan-to-income tightening when debt is high and monetary policy cannot accommodate.

Investigation of the weldability of PA6 and CF/PA6 based on a servo-driven ultrasonic welder without using energy director

For ultrasonic welding (USW) of fiber reinforced thermoplastic composites without energy director (ED), the special contact surface and interphase structures due to the addition of fibers have strong relation to the weld quality. In this study, through the servo-driven USW experiments and the corresponding mini-anisotropy modeling for PA6 and CF/PA6 composites welding without ED, the fusion phenomena and weldability of the materials are addressed. The results show that as compared to pure PA6, CF/PA6 has the higher loss modulus and lower specific capacity, leading to more viscoelastic heat generation during USW. As the CF/PA6 surface has the higher roughness, the more significant local stress and energy concentrations occur around the initial contact area, leading to the increased welding area; while more pores are observed within the joints of composites due to the poor liquidity and air trap from larger contact gap. Due to the interphase structure between CF and PA6, the high strain and high temperature occur around the fibers, where pores form due to thermal decomposition.

Strategic mistakes

To study the equilibrium implications of decision frictions, we introduce a new class of control costs in continuum-player, continuum-action games in which agents interact via an aggregate of the actions of others. The costs that we study accommodate a rich class of decision frictions, including ex post misoptimization, imperfect ex ante planning, cognitive constraints that depend endogenously on the behavior of others, and consideration sets. We provide primitive conditions such that equilibria exist, are unique, are efficient, and feature monotone comparative statics for action distributions, aggregates, and the size of agents' mistakes. We apply the model to make robust equilibrium predictions in a monetary business-cycle model of price-setting with planning frictions and a model of consumption and savings during a liquidity trap when endogenous stress worsens decisions.

A quarter of a century of the BoJ’s efforts to overcome liquidity trap

Japan was the first country to experience sustained deflationary threat since the late 1990s. It stemmed from a mixture of factors of different natures, out of which domestic structural rigidities and the Great Moderation played the key role. Confronting these pressures were not easy for the Bank of Japan (BoJ). This process was lengthy and associated mistakes in monetary policy decisions proved to be unavoidable, but it led to the transition of the BoJ from an obsolete institution into a bold, innovative central bank, which since 2013 has started to set new trends in the monetary policies worldwide. Inflation, however, remained well below the 2% price stability target for most of the time over the recent decade. Inflation has begun to exceed the target significantly since early 2022. However, the BoJ stresses that the current high inflation is unsustainable due to temporary external factors and that it will fall below 2% in the near future. The ability to keep inflation at around 2% depends on sustainable wage and demand growth, as well as on the policies pursued by Kuroda’s successor.

Evaluation of fiscal policy using alternative GDP data in Japan

In macroeconomics, the effectiveness of fiscal policy is an old, but new controversial question that has been debated for many years. The controversy naturally arises if analytical frameworks, sample periods, or targeted countries are different. However, it sometimes arises, even when using similar analytical frameworks and sample periods. The purpose of this study is to explore whether revisions to the GDP data series are a source of the controversy in Japan. Since the mid-1990s, the Japanese economy has remained stuck in a liquidity trap where interest rates have fallen to zero. However, not only has the cumulative fiscal deficit increased to an unprecedented level, but many structural problems have also emerged. Under these circumstances, it is unclear whether the fiscal policy has worked effectively in the Japanese economy. When a reduced-form equation or VAR model was estimated, the empirical findings were quite different depending on GDP benchmark year we used in the analysis. When benchmark year 2011 was used, fiscal expenditure was effective under ultralow interest rates. In contrast, when benchmark year 2015 was used, it was not effective, especially since around 2010, even under ultra-low interest rates. This implies that in Japan, the effectiveness of fiscal policy must be carefully interpreted, noting which GDP benchmark year is used in the analysis.

Monetary policy inertia and the paradox of flexibility

This paper revisits the paradox of flexibility, i.e., the result that, in a liquidity trap, greater price flexibility amplifies output volatility in response to negative demand shocks. We argue this paradox is the consequence of a failure of standard models to correctly characterise monetary policy at the zero lower bound. We show that allowing for a smooth adjustment of the shadow policy rate eliminates the paradox and produces output responses to a negative demand shock that are in line with those under optimal monetary policy. The reason is that, under an inertial policy, a decline in the shadow rate implies that the future actual policy rate will remain relatively low, which increases expectations about the economic outlook and inflation. The rise in inflation expectations reduces the real rate, thereby sustaining real activity. As we raise the degree of price flexibility, a negative demand shock causes a sharper fall in the shadow rate and increase in inflation expectations, which leads to a more significant drop in the real rate and, hence, a milder decline in the output gap.

House Price Dynamics, Optimal LTV Limits and the Liquidity Trap

Abstract This paper studies the optimal design of a macro-prudential instrument, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The analysis accounts for both an effective lower bound on the nominal interest rate and an upper bound on the ability of LTV limits to stimulate credit demand. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.

Subsidizing new jobs in the Euro-zone periphery

The macroeconomic effects of a selective wage subsidy targeted to new labour hires are evaluated and compared with those of standard fiscal instruments. The analyses are based on a search and matching monetary model in which a distinction between the wage negotiated by newly-hired workers and incumbents is introduced. The model is estimated using data for high unemployment countries of the Euro-zone periphery. We show that, although the labour market policy can be an effective measure to jump-start employment, it is not superior to standard fiscal expansions in stimulating a timely response of economic activity. A liquidity trap environment reinforces these results, showing that policy actions triggering a deflation can be pro-cyclical with zero interest rates.

The paradox of price flexibility in an open economy

Empirical evidence suggests that the degree of price stickiness is not uniform around the world. Heterogeneous price stickiness introduces a new propagation mechanism of global demand shocks that lead to a liquidity trap for all countries, which we call the open-economy paradox of flexibility. We show that the severity of the paradox increases with the degree of trade and capital market openness, when home and foreign goods are Edgeworth substitutes and when the more affected home country runs a trade deficit. This implies that highly open trade and financial linkages are not desirable in terms of world welfare. We show that the inefficiencies generated by heterogeneous price stickiness can be reduced through two types of international policy coordination: i) an arrangement in which the country with relatively sticky prices raises the interest rates or ii) a monetary union.

Forecasting term structure of the Japanese bond yields in the presence of a liquidity trap

AbstractThe Nelson–Siegel (NS) model is widely used in practice to fit the term structure of interest rates largely due to its high efficacy in the in‐sample fit and out‐of‐sample forecasting of bond yields. In this paper, we compare forecasting performances of estimated yields from the Nelson–Siegel‐based models and some simpler time series models, using the daily, weekly, and monthly data during a prolong period of liquidity trap in Japan. We find that the out‐of‐sample expanding window forecasts by NS‐based models in general perform less satisfactory than the competitor models. However, the NS‐based models can be useful in forecasting yields over longer horizons and can work well with GARCH‐type structures in modeling the conditional volatility.