DP11369 Money and Capital in a Persistent Liquidity Trap

Author(s):	Philippe Bacchetta, Kenza Benhima, Yannick Kalantzis
Publication Date:	July 2016
Keyword(s):	Asset scarcity, Deleveraging, liquidity trap, zero lower bound
JEL(s):	E22, E40, E58
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=11369

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.