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Safe asset shortages can expose an economy to liquidity traps. The nature of these traps is determined by the cyclicality of the bond premium. A counter-cyclical bond premium opens the possibility of expectations-driven liquidity traps in which small issuances of government debt crowd out private debt and reduce output. In contrast, when the bond premium is pro-cyclical and the economy is in a liquidity trap, government debt is expansionary. In the data, we find evidence of a counter-cyclical bond premium. Large interventions can prevent the emergence of self-fulfilling traps, but they require sufficient fiscal capacity. In a quantitative model calibrated to the Great Recession, a promise to increase the government debt-to-GDP ratio by 20 percentage points precludes the possibility of self-fulfilling traps.

The Nelson–Siegel (NS) model is widely used in practice to fit the term structure of interest rates largely due to its high efficacy in the in‐sample fit and out‐of‐sample forecasting of bond yields. In this paper, we compare forecasting performances of estimated yields from the Nelson–Siegel‐based models and some simpler time series models, using the daily, weekly, and monthly data during a prolong period of liquidity trap in Japan. We find that the out‐of‐sample expanding window forecasts by NS‐based models in general perform less satisfactory than the competitor models. However, the NS‐based models can be useful in forecasting yields over longer horizons and can work well with GARCH‐type structures in modeling the conditional volatility. [ABSTRACT FROM AUTHOR]

In a New Keynesian model, it is believed that combining active monetary policy using a Taylor rule with a passive fiscal rule can achieve local equilibrium determinacy. However, even with such policies, indeterminacy can occur from the emergence of a Shilnikov chaotic attractor in the region of the feasible parameter space. That result, shown by Barnett et al. (2022a), "Shilnikov Chaos, Low Interest Rates, and New Keynesian Macroeconomics," Journal of Economic Dynamics and Control 134, and again by Barnett et al. (2022b), "Is Policy Causing Chaos in the United Kingdom," Economic Modeling 108, implies that the presence of the Shilnikov chaotic attractor can cause the economy to drift towards and finally become stuck in the vicinity of lower-than-targeted inflation and nominal interest rates. The result can become the source of a liquidity trap phenomenon. We propose policy options for eliminating or controlling Shilnikov chaotic dynamics to help the economy escape from the liquidity trap or avoid drifting into it in the first place. We consider ways to eliminate or control the chaos by replacing the usual Taylor rule by an alternative policy design without interest rate feedback, such as a Taylor rule with monetary quantity feedback, an active fiscal policy rule with passive monetary rule, or an open loop policy without feedback. We also consider approaches that retain the Taylor rule with interest rate feedback and the associated Shilnikov chaos, while controlling the chaos through a well-known engineering algorithm using a second policy instrument. We find that a second instrument is needed to incorporate a long-run terminal condition missing from the usual myopic Taylor rule. [ABSTRACT FROM AUTHOR]

The negative natural rate of interest is since two decades eliciting theoretical and policy debates. It re-emerged, after a relatively long time, in Krugman's Liquidity Trap model. Later, it was placed at the hearth of the Secular Stagnation theory by Summers. It is argued that Krugman's negative natural rate of interest ensues from theoretical premises analogous to those present in Samuelson's overlapping-generations model. In turn, Samuelson obtained a negative equilibrium interest rate by opportunely recasting Böhm-Bawerk's three causes for a positive rate of interest. The present paper illustrates and analyses this line of thought until its recent developments. [ABSTRACT FROM AUTHOR]

This paper examines the Taylor rule in the context of United States monetary policy since 1965, particularly with respect to the zero-lower-bound era of the federal funds rate from 2009 to 2016. A nonlinear Taylor rule is developed which features smooth transitions in the first two moments of the federal funds rate. This flexible specification is found to usefully capture observed nonlinearity, while accounting for the well-documented structural changes in monetary policy formation at the Federal Reserve in the last 50 years, and especially in the recent zero-lower-bound era. [ABSTRACT FROM AUTHOR]

This article analyzes the limits of monetary policy from a theoretical perspective. The analysis parts from Keynes's theory presented in the General Theory in which the ideal of the liquidity trap is highlighted. Other limits faced by monetary authorities are also recognized, the analysis of uncertainty and expectations being fundamental. This is opposed to the concept of the zero lower bound (ZLB) which is used to indicate the current limits of monetary policy. The article concludes that the lack of current recognition of expectations prevents monetary policy from exceeding the limits it faces, rescuing the important role that fiscal policy plays as an alternative to influence the economic cycle. [ABSTRACT FROM AUTHOR]

The article considers the downward spiral of deflation, its causes and consequences. The paper discusses the compression of aggregate demand and the subsequent recession. The study discloses the content of the liquidity trap created by the behavior of borrowers. The author traces the connection between the events of the “lost decades” in Japan and the stagnation of production in leading Western countries after the global financial crisis. In both cases, the large-scale use of fiscal and monetary incentives did not cause a sharp rise in business activity. The paper concludes that the operation of the market mechanism is blocked by budget and monetary policies. Obstacles to entrepreneurial activity and energy lead to the loss of necessary information generated by market agents. This circumstance prolongs the stagnation of the economy.

The study investigates the effect of New Keynesian liquidity trap on fiscal stance in the United States, United Kingdom and Japan economies. We developed our DSGE model in the context of an optimal and persistent interactive fiscal policy, which allows us to track the transmission channel through which shocks are distributed among real economic variables. The evidence suggests that zero lower bound mitigates the ability of monetary policy to absorb the effect of exogenous shock on the macroeconomic variables while expansionary fiscal policy was able to absorb the shock persistence transmitted from the nominal interest rate.

When a country falls into a liquidity trap it means that its central bank lacks an effective expansionary monetary policy aimed at increasing consumption and investment demand. Market participants (households and enterprises), instead of increasing demand, accumulate a growing money supply in the form of cash. Keynes argued that for an economy in a liquidity trap, the only way to increase demand in the country and to stimulate the economy is to conduct expansionary fiscal policy by increasing government spending or reducing taxes. The aim of the research is to verify the empirical hypothesis of the liquidity trap in three of the largest economies in the world, formerly known as the Global Triad (i.e. the USA, the euro zone and Japan), after the 2008 financial crisis. Research methods based on literature studies in macroeconomics and finance, as well as statistical methods, were used in the study. All statistical data came from the statistical office of the European Union – EUROSTAT, and from the statistical database of the United Nations Conference on Trade and Development - UNCTADstat.

Central banks face uncertainty about the true location of the effective lower bound (ELB) on nominal interest rates. We model optimal discretionary monetary policy during a liquidity trap when the central bank designs policy that is robust with respect to the location of the ELB. If the central bank fears the worst-case location of the ELB, monetary conditions will be more expansionary in the period before the liquidity trap. [ABSTRACT FROM AUTHOR]

Quantitative easing (QE) ineffectiveness in periods of liquidity trap conditions has been empirically verified for Japan, USA, and the Eurozone, on the basis of a switching regimes approach. In this work, we present further evidence that unconventional monetary policies are impotent when policy rates are close to their lower bound, using monthly data from Sweden, Switzerland, and the UK, whose central banks also pursued QE policies in the aftermath of the 2008 financial crisis. For all the economies considered, we obtain evidence of drastic regime shifts for base money growth which are successfully captured by a Markov switching regimes representation, but inflation, investment expenditure growth, and broad money growth do not appear to change significantly in different QE policy regimes, thus pointing to unconventional monetary policy impotence. [ABSTRACT FROM AUTHOR]

Prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations ineffective for achieving macroeconomic stabilization goals. We show that even were this the case, there remains a powerful argument for large-scale open market operations as a fiscal policy tool. As we also demonstrate, however, this same reasoning implies that open-market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open-market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan’s recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japan’s predicament. We argue Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.

This paper examines a search model of money and public bonds in which coordination frictions lead to multiple, Pareto ranked equilibria. Whether money and bonds are substitutes or complements, is not a primitive of the economy, but an equilibrium outcome. There exists an equilibrium resembling a liquidity trap, in which money and bonds are perfect substitutes, interest rates are zero, and monetary policy is ineffective; and a superior equilibrium in which money and bonds are complements, interest rates are positive and monetary policy has a liquidity effect. On this view, the liquidity trap is a belief‐driven phenomenon. [ABSTRACT FROM AUTHOR]

I study liquidity traps in a model where agents have heterogeneous expectations and finite planning horizons. Backward-looking agents base their expectations on past observations, while forward-looking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expectations can arise due to pessimism of backward-looking agents. Only when planning horizons are finite, these liquidity traps can be of longer duration without ending up in a deflationary spiral. I further find that fiscal stimulus in the form of an increase in government spending or a cut in consumption taxes can be very effective in mitigating the liquidity trap. A feedback mechanism of heterogeneous expectations causes fiscal multipliers to be the largest when the majority of agents are backward-looking but there also is a considerable fraction of agents that are forward-looking. Labor tax cuts are always deflationary and are not an effective tool in a liquidity trap. [ABSTRACT FROM AUTHOR]

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Improper working capital policies may put companies in a situation where they may have difficulty securing their cash resources; in the financial sector, this is called a liquidity trap. The liquidity trap implies the inability of companies to provide cash resources due to inappropriate working capital policies. Theoretically speaking, companies falling into the liquidity trap have difficulty in fulfilling their obligations and paying off debts, due to applying proper liquidity policies; resulting from lack of cash flows or cash outflows, due to the internal or external factors, they are subject to financial limitations and ultimately bankruptcy. The purpose of this study is to investigate whether the companies listed in the Tehran Stock Exchange that have been fallen in the liquidity trap, eventually go bankrupt; using the data of 206 companies in the period of 2008- 2017 and based on the liquidity trap prediction model of Vakili Fard et al., the financial limitation prediction models of Kaplan and Zingales, Witedo and modified Kaplan and Zingales, as well as modified Altman bankruptcy prediction models and genetic algorithm, we examined this hypothesis. Confirming the research hypothesis, it was concluded that companies with liquidity trap go bankrupt, unless they reform or change their working capital policies. [ABSTRACT FROM AUTHOR]

The monetary transmission channel is disrupted by many factors, especially securitization and liquidity traps. In our study we try to estimate the effect of securitization on the interest elasticity and to identify if a liquidity trap occurred during 1954Q3-2019Q3. The yield curve inversion mechanism shows us that economic cycles are very sensitive to decreasing profitability of banks. However there is no evidence that restoring their profits will ensure a strong recovery. In this regard, we research the low effect of Quantitative Easing (QE) upon economic growth and analyze whether securitization and liquidity traps posed challenges to QE or is it the mainstream theory flawed. In this regard we will examine the main weaknesses of QE, respectively the speculative behavior induced by artificial low rates and its unequal distribution. We propose a new form of QE that will relief households and not reward banks for their risky behavior before recession. [ABSTRACT FROM AUTHOR]

Krugman's 'liquidity trap' model constituted a ground-breaking contribution by attributing the long-lasting Japanese stagnation to a negative natural interest rate. Our critique to such a proposal will focus on three aspects. First, we will question the logical structure of the model, providing an alternative interpretation of its closure and arguing that aggregate demand has no crucial role in it. Second, we will argue that a negative natural interest rate can emerge only after a series of overtly restrictive assumptions in a model that does not treat capital and avoids long-run equilibrium analysis. Finally, we will discuss the mainstream literature which followed up until the recent rediscovery of the Secular Stagnation Theory. Within that line of literature, the key features of the 'liquidity trap' model continue to occupy a prominent role, thereby letting the critical issues that have been singled out resurface. Our conclusion is that the 'liquidity trap' explanation did not provide a satisfying rationale for Japan's stagnation and cannot describe later economic predicaments either. A comparison with Post-Keynesian models shows their ability to offer insightful policy prescriptions without relying on those shaky theoretical foundations. [ABSTRACT FROM AUTHOR]

Keynes emphasized a specific situation in which the liquidity preference becomes absolute, leading to monetary policy ineffectiveness when nominal interest approaches the zero-bound rate. This situation was termed a liquidity trap (LT) by Robertson and was popularized by the Hicks-Hansen framework (IS-LM). Early macroeconomic textbooks characterized the LT as the Keynesian case against the classical one. The "lowflation" environment experienced in the USA and Europe again brought the LT to the forefront. The quantitative easing monetary policy was introduced in Japan and better applied in the USA and EMU as a solution to overcome the LT. The macroeconomic mainstream contends that the LT is essentially a money demand problem, whereas we propose another interpretation; the current situation should be interpreted as a "banking problem" that impedes the transformation of the monetary base into money supply. To prove our thesis, we study the behavior of the USA money multiplier and the income velocity of money by comparing an earlier period with the 2007-2008 crisis period. Using a VAR and a VECM model, we compare the normal situation of monetary policy efficiency with the situation of LT monetary policy inefficiency. We prove that the LT focus should not be placed on the demand for money but rather on the behavior of the money supply - more specifically, on banks' behavior leading to the transformation of the monetary base into the money supply. [ABSTRACT FROM AUTHOR]

This paper constructs a two‐country core–periphery New Keynesian model of a currency union to address the interaction between the objectives of regionally directed fiscal policy constrained by a single currency and the aggregate use of fiscal policy in face of the zero lower bound (ZLB) on policy interest rates. We identify an optimal path of aggregate and relative fiscal policy responses to a negative region‐specific demand shock. Our results show that (i) in a monetary union, the optimal policy response to an asymmetric reduction in demand concentrated in the periphery always entails a relative shift of fiscal expenditure toward the worse‐affected regions, (ii) though no aggregate fiscal response is required outside the ZLB, and (iii) optimal union‐wide fiscal policy is expansionary at the ZLB. Therefore, optimal policy always entails an expansion in the periphery at the ZLB, but the optimal fiscal response in the core regions can be either expansionary or contractionary depending on the parameters of the model. However, (iv) fiscal expansion in the core is warranted if the periphery cannot implement an expansion due to constraints on public spending. [ABSTRACT FROM AUTHOR]

We determine optimal monetary policy under commitment in a forward-looking New Keynesian model when nominal interest rates are bounded below by zero. The lower bound represents an occasionally binding constraint that causes the model and optimal policy to be nonlinear. A calibration to the U.S. economy suggests that policy should reduce nominal interest rates more aggressively than suggested by a model without lower bound. Rational agents anticipate the possibility of reaching the lower bound in the future and this amplifies the effects of adverse shocks well before the bound is reached. While the empirical magnitude of U.S. mark-up shocks seems too small to entail zero nominal interest rates, shocks affecting the natural real interest rate plausibly lead to a binding lower bound. Under optimal policy, however, this occurs quite infrequently and does not imply positive average inflation rates in equilibrium. Interestingly, the presence of binding real rate shocks alters the policy response to (non-binding) markup shocks. [ABSTRACT FROM AUTHOR]

We estimate the long-run Japanese money demand function in a cointegration framework with two nonlinear functional forms that allow for the liquidity trap, and compare the results with the standard log-level functional form. In addition to the conventional linear cointegration techniques, we also use a recently developed procedure for nonlinear cointegration that allows the estimation of alternative functional forms under the same assumption regarding the trend properties of the nominal interest rate. The nonlinear functional forms outperform the log-level functional form based on out-of-sample prediction performance. [ABSTRACT FROM AUTHOR]

Most current literature assumes that a central bank loses the ability to influence interest rates through variations in reserve supply as soon as overnight rates have been driven to zero. I argue that reserve supply can be directly related to longer-term rates when overnight rates are zero because banks' reserve demand is then defined by the role of cash as an asset free of interest-rate risk. I present evidence that reserve supply affected longer-term interest rates in the U.S. from 1934 through 1939, while overnight rates were at the zero floor, even when the changes in reserve supply reflected factors unlikely to have affected expectations of future overnight rates. [ABSTRACT FROM AUTHOR]

What should a central bank do when faced with a weak aggregate demand even after reducing the short-term nominal interest rate to zero? To address this question, we solve a central bank's intertemporal loss-minimization problem, in which the non-negativity constraint on nominal interest rates is explicitly considered. We find that the optimal path is characterized by policy inertia, in the sense that a zero interest rate policy should be continued for a while even after the natural rate of interest returns to a positive level. By making such a commitment, the central bank is able to achieve higher expected inflation, lower long-term nominal interest rates, and a weaker domestic currency in the adverse periods when the natural rate of interest significantly deviates from a steady-state level. [ABSTRACT FROM AUTHOR]

Prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open-market operations ineffective for achieving macroeconomic stabilization goals. We show that even were this the case, there remains a powerful argument for large-scale open market operations as a fiscal policy tool. As we also demonstrate, however, this same reasoning implies that open-market operations will be beneficial for stabilization as well, even when the economy is expected to remain mired in a liquidity trap for some time. Thus, the microeconomic fiscal benefits of open-market operations in a liquidity trap go hand in hand with standard macroeconomic objectives. Motivated by Japan’s recent economic experience, we use a dynamic general-equilibrium model to assess the welfare impact of open-market operations for an economy in Japan’s predicament. We argue Japan can achieve a substantial welfare improvement through large open-market purchases of domestic government debt.

Japan’s more than a decade long “Great Recession” has presented a disconcerting case of what could happen if interest rates are bounded by zero and deflation sets in. Since Krugman (1998), the commonplace observation is that the deflationary situation combined with the zero nominal interest rate has caused elevated real interest rates, thereby nullifying monetary policy. This paper investigates this oft -cited claim and examines whether it is associated with anomalies in the way real interest rates are determined by employing an error correction model (ECM) based on the time-varying parameter model with Markov-switching variances. Using this model it is revealed that during the 1980s both ex ante and ex post rates were often lower than the equilibrium rates, indicating strong and persistent optimism among agents. However in the 1990s the ex ante real interest rate was persistently higher than the equilibrium, indicating the pessimistic expectations among agents. The time-varying speed of convergence to the equilibrium appears to slow down considerably in 1996-99, making the misalignment in the real interest rate process last twice as long as in the 1980s. In addition the analysis using the Smooth Transition Regression (STR) model shows a regime shift in the real rate process in mid-1995, three years before the implementation of the zero interest rate policy. This result suggests that a situation with an extremely low nominal interest rate, even before it reaches the zero bound, may create anomalies or nonlinearity in the effectiveness of monetary policy.

The Japanese economy is showing signs of a moderate recovery after more than two decades of stagnation. This stagnation was characterized by low inflation or outright deflation, subdued long-term interest rates, elevated government debt and chronic fiscal deficits, and the decline in its share of global exports. Monetary policy has been highly accommodative, marked by low and negative policy rates and the expansion of the central bank's balance sheet. The country has been mired in a liquidity trap. Despite the recent recovery, observed inflation is still below the Bank of Japan's target of 2.0%. Wage growth is muted even though the unemployment rate is low. Meanwhile, the working-age population continues to shrink, and the general population is rapidly aging. Japan's export sector faces stiff competition. Openness to immigration is quite limited. This article analyzes Japan's economic challenges in light of the moderate recovery after the protracted stagnation, ongoing demographic changes, the reforms of Abenomics, and globalization. [ABSTRACT FROM AUTHOR]

The negative interest rate, like zero-close, is an old-fashioned phenomenon in economic policy, which is increasingly involved in post-crisis monetary policy, hiterest, as the tune value of money, can only be positive in some macromodels, which is linked to the liquidity premium and the "impotence factor". Anyone who wants to use money to buy goods in the present has to pay a premium to those who are willing to give up on it. At the same time, monetary practice has evolved in the opposite dir ection in several countries over the past period. One of the most spectacular appearances of the modem history of the negative "savings saver" interest rate is the negative rate imposed on the depositor at the central bank. The negative interest rate was used by the major banks, the ECB, the Swiss and Japanese central banks. After the crisis in 2007, the central banks of the developed world kept their standard rates close to zero for a long tune after 2009. Following the crisis, the central bank's rescue operation proved to be successful in the fact that the world economy did not collapse, no second serious economic crisis happened. The "success", however, has a price: the fact that central banks can not raise interest rates because they would risk a recession instead of stagnation. This situation does not cause any problems, while the rise in inflation does not necessitate interest rate hikes. For a significant part of the world economy, there is no need to keep inflation threatened for some time, but the trend of interest rate rise has been observed in several countries. [ABSTRACT FROM AUTHOR]