Working Paper: CEPR ID: DP2548
Authors: Harald Uhlig
Abstract: Should one think of zero nominal interest rates as an undesirable liquidity trap or as the desirable Friedman rule? I use three different frameworks to discuss this issue. First, I restate Cole and Kocherlakota's (1998) analysis of Friedman's rule: short run increases in the money stock - whether through issuing spending coupons, open market operations or foreign exchange intervention - change nothing as long as the money stock shrinks in the long run. Second, two simple ?Keynesian? models of the inflationary process with a zero lower bound on nominal interest rates imply either that deflationary spirals should be common or that a policy close to the Friedman rule and thus some deflation is optimal. Finally, a formal ?baby-sitting coop? model implies multiple equilibria, but does not support the injection of liquidity to restore the good equilibrium, in contrast to Krugman (1998).
Keywords: babysitting coop; cash in advance; deflation; deflationary spiral; Friedman's rule; Japan; liquidity trap; optimal monetary policy; zero lower bound on nominal interest rates
JEL Codes: E31; E41; E50; E51; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short-run increases in the money stock (E51) | long-run equilibrium (D59) |
| nominal interest rates set at zero (E43) | prolonged deflationary spirals (E31) |
| policy aligned with Friedman's rule (E61) | optimal economic outcome (D61) |
| injecting liquidity (E41) | restore 'good' equilibrium (D50) |
| injecting liquidity (E41) | exacerbate the situation (Y60) |