Working Paper: CEPR ID: DP13334
Authors: Florin Ovidiu Bilbiie
Abstract: Liquidity traps can be either fundamental, or confidence-driven. In a simple unified New-Keynesian framework, I provide the analytical condition for the latter's prevalence: enough shock persistence and endogenous intertemporal amplification of future ("news") shocks, making income effects dominate substitution effects. The same condition governs Neo-Fisherian effects (expansionary-inflationary interest-rate increases) which are thus inherent in confidence traps. Several monetary-fiscal policies (forward guidance, interest rate increases, public spending, labor-tax cuts) have diametrically opposed effects according to the trap variety. This duality provides testable implications to disentangle between trap types; that is essential, for optimal policies are likewise diametrically opposite.
Keywords: Confidence and fundamental liquidity traps; Neofisherian monetary policy; Forward guidance; Fiscal multipliers; Optimal policy
JEL Codes: E3; E4; E5; E6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| interest rate increases (E43) | inflation (E31) |
| confidence-driven liquidity trap (E41) | interest rate increases (E43) |
| fundamental liquidity trap (E41) | interest rate increases (E43) |
| interest rate increases (E43) | deflation (E31) |
| liquidity trap type (E41) | policy effectiveness (D78) |