A Model of U.S. Monetary Policy Before and After the Great Recession
Abstract: The author studies a simple dynamic general equilibrium monetary model to interpret key macroeconomic developments in the U.S. economy both before and after the Great Recession. In normal times, when the Federal Reserve?s policy rate is above the interest paid on reserves, countercyclical monetary policy works in a textbook manner. When a shock drives the policy rate to the zero lower bound, the economy enters a liquidity-trap scenario in which open market purchases of government securities have no real or nominal effects, apart from expanding the supply of excess reserves in the banking sector. In a liquidity trap, the Fed loses all control of inflation, which is now determined entirely by the fiscal authority. In normal times, raising the interest paid on reserves stimulates economic activity, but in a liquidity trap, raising the interest paid on reserves retards economic activity.
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Description: Full text
Provider: Federal Reserve Bank of St. Louis
Part of Series: Review
Publication Date: 2015