Liquidity Traps and Monetary Policy: Managing a Credit Crunch

Abstract: We study a model with heterogeneous producers that face collateral and cash-in-advance constraints. A tightening of the collateral constraint results in a credit-crunch-generated recession that reproduces several features of the ?nancial crisis that unraveled in 2007 in the United States. The model can be used to study the effects of the credit-crunch on the main macroeconomic variables and the impact of alternative policies. The policy implications regarding forward guidance are in contrast with the prevalent view in most central banks, based on the New Keynesian explanation of the liquidity trap.

Keywords: Monetary policy; Ricardian equivalence; Credit crunch; Liquidity trap; Collateral constraints;

JEL Classification: E52; E44; E58; E63;

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Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2017-02-02

Number: 540

Pages: 46 pages