Working Paper: CEPR ID: DP17290
Authors: Gianluca Benigno; Pierpaolo Benigno
Abstract: We propose a new framework for monetary policy analysis to study monetary policy normalization when exiting a liquidity trap. The optimal combination of reserves and interest rate policy requires an increase in liquidity (reserves) a few quarters after the policy rate is set at the effective lower bound. Removal of accommodation requires that quantitative tightening starts before the liftoff of the policy rate. Moreover, the withdrawal of liquidity takes place at a very slow pace relative to the normalization of the policy rate.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in liquidity reserves (E51) | timing of policy rate adjustments (E52) |
| timing of quantitative tightening (C54) | normalization of the policy rate (E52) |
| speed of liquidity withdrawal (E41) | normalization of the policy rate (E52) |
| reserve management (Q26) | liquidity premium (E41) |
| liquidity premium (E41) | aggregate demand (E00) |
| monetary policy tools (E52) | economic outcomes (F61) |
| monetary policy tools (E52) | inflation and output (E31) |