Author(s):	Florin Ovidiu Bilbiie
Publication Date:	November 2018
Date Revised:	November 2018
Keyword(s):	confidence and fundamental liquidity traps, Fiscal multipliers, forward guidance, monetary policy, neo-Fisherian, optimal policy
JEL(s):	E3, E4, E5, E6
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=13334

Liquidity traps can be either fundamental, or confidence-driven. In a simple unified New-Keynesian framework, I provide the analytical condition for the latter's prevalence: enough shock persistence and endogenous intertemporal amplification of future ("news") shocks, making income effects dominate substitution effects. The same condition governs Neo-Fisherian effects (expansionary-inflationary interest-rate increases) which are thus inherent in confidence traps. Several monetary-fiscal policies (forward guidance, interest rate increases, public spending, labor-tax cuts) have diametrically opposed effects according to the trap variety. This duality provides testable implications to disentangle between trap types; that is essential, for optimal policies are likewise diametrically opposite.