Working Paper: NBER ID: w26277
Authors: Guillermo A. Calvo
Abstract: The paper discusses simple microfoundations for Liquidity Deflation (Calvo 2016, Chapter 2), which gives rise to liquidity trap under perfectly flexible prices/wages. Unlike Keynes (1936), this is a Supply Side Liquidity Trap, SSLT, not resolved by a fall in prices /wages, or massive helicopter increase in liquid government liabilities. However, escaping SSLT could be achieved by low policy interest rates on money (unless ZLB holds) and, more interestingly, higher inflation driven by administered prices/wages. Moreover, contrary to (Friedman 1969), under Liquidity Deflation the Optimal Quantity of Money does not call for liquidity satiation, and may be dangerously close to SSLT.
Keywords: liquidity deflation; liquidity trap; flexible prices; monetary policy; safe assets
JEL Codes: E31; E4; E41; E5; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity deflation (E41) | supply-side liquidity trap (SSLT) (E51) |
| increase in supply of real safe assets (G19) | liquidity deflation (E41) |
| operating near complete crowd-out equilibrium (D52) | equilibrium indeterminacy (D59) |
| liquidity deflation (E41) | sharp increase in price levels (E30) |
| liquidity deflation conditions (E44) | optimal quantity of money (OQM) does not necessitate liquidity satiation (E41) |