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Title: Money and Capital in a Persistent Liquidity Trap

Author(s): Philippe Bacchetta, Kenza Benhima and Yannick Kalantzis

Publication Date: July 2016

Keyword(s): Asset scarcity, Deleveraging, liquidity trap and zero lower bound

Programme Area(s): Monetary Economics and Fluctuations

Abstract: In this paper we analyze the implications of a persistent liquidity trap in a monetary model with asset scarcity and price flexibility. We show that a liquidity trap leads to an increase in cash holdings and may be associated with a long-term output decline. This long-term impact is a supply-side effect that may arise when agents are heterogeneous. It occurs in particular with a persistent deleveraging shock, leading investors to hold cash yielding a low return. Policy implications differ from shorter-run analyses. Quantitative easing leads to a deeper liquidity trap. Exiting the trap by increasing expected inflation or applying negative interest rates does not solve the asset scarcity problem.

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Bibliographic Reference

Bacchetta, P, Benhima, K and Kalantzis, Y. 2016. 'Money and Capital in a Persistent Liquidity Trap'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11369