Working Paper: CEPR ID: DP2203
Authors: Willem H. Buiter; Nikolaos Panigirtzoglou
Abstract: The paper considers ways of avoiding a liquidity trap and ways of getting out of one. Unless lower short nominal interest rates are associated with significantly lower interest volatility, a lower average rate of inflation, which will be associated with lower expected nominal interest rates, increases the odds that the zero nominal interest rate floor will become a binding constraint. The empirical evidence on this issue is mixed.Once in a liquidity trap, there are two means of escape. The first is to use expansionary fiscal policy. The second is to lower the zero nominal interest rate floor. This second option involves paying negative interest on government 'bearer bonds' -- coin and currency, that is 'taxing money', as advocated by Gesell. This would also reduce the likelihood of ending up in a liquidity trap. Taxing currency amounts to having periodic 'currency reforms', that is, compulsory conversions of 'old' currency into 'new' currency, say by stamping currency. The terms of the conversion can be set to achieve any positive or negative interest rate on currency. There are likely to be significant shoe leather costs associated with such schemes. The policy question then becomes how much shoe leather it takes to fill an output gap?Finally the paper develops a simple analytical model showing how the economy can get into a liquidity trap and how Gesell money is one way of avoiding it or escaping from it.
Keywords: liquidity trap; Gesell; stamp scrip; inflation-targeting; multiple equilibria
JEL Codes: B22; E31; E32; E51; E52; E58; N12; N13; N14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lower average rates of inflation (E31) | Increase likelihood of encountering a liquidity trap (E41) |
| Lower expected nominal interest rates (E43) | Increase likelihood of encountering a liquidity trap (E41) |
| Expansionary fiscal policy (E62) | Escape from liquidity trap (E49) |
| Negative interest rates on currency (E43) | Reduce likelihood of landing in a liquidity trap (E43) |