Zero Nominal Interest Rates, Unemployment, Excess Reserves and Deflation in a Liquidity Trap

We present a dynamic and monetary model that consistently explains such various phenomena as unemployment, deflation, zero nominal interest rates and excess reserves held by commercial banks. These phenomena are commonly observed during the Great Depression in the United States, the recent long-run stagnation in Japan, and the worldwide financial crisis triggered by the US subprime loan problem of 2008. We show that an excessive liquidity preference leads to a liquidity trap and thereby generates the phenomena.

Growth, Stagnation and Status Preference

We consider three objects of people's status preference, consumption, physical capital holding and money holding, and show that an economy grows or stagnates depending on which object people most seriously take as status. If the main object of status preference is consumption, a steady state with full employment is reached. If it is physical capita (viz. a producible asset), permanent growth with full employment occurs. However, if it is money (viz. an unproducible asset), stagnation with persistent unemployment arises.

A Reinterpretation of the Keynesian Consumption Function and Multiplier Effect

We propose a microeconomic foundation of the multiplier effect and that of the consumption function using a dynamic optimization model that explains a shortage of aggregate demand and unemployment. We show that government purchases boost aggregate demand through a multiplier-like process but that the implication is quite different. It works through not an increase in disposable income but moderation of deflation, which makes money holding costly and stimulates consumption.

Negative interest rate policy in a permanent liquidity trap

Using a dynamic general equilibrium model, this paper theoretically analyzes a negative interest rate policy in a permanent liquidity trap. If the natural nominal interest rate is above the lower bound set by the presence of vault cash held by commercial banks, a reduction in the nominal rate of interest on excess bank reserves can get an economy out of the permanent liquidity trap. In contrast, if the natural nominal interest rate is below the lower bound, then it cannot do so, but instead a rise in the rate of tax on vault cash is useful for doing so

Negative interest rate policy in a permanent liquidity trap

Using a dynamic general equilibrium model, this paper theoretically analyzes a negative interest rate policy in a permanent liquidity trap. If the natural nominal interest rate is above the lower bound set by the presence of vault cash held by commercial banks, a reduction in the nominal rate of interest on excess bank reserves can get an economy out of the permanent liquidity trap. In contrast, if the natural nominal interest rate is below the lower bound, then it cannot do so, but instead a rise in the rate of tax on vault cash is useful for doing so