Inside Money, Investment, and Unconventional Monetary Policy

By Likas Altermatt

http://d.repec.org/n?u=RePEc:red:sed019:470&r=dge

I develop a new monetarist model to analyze why an economy can fall into a liquidity trap, and what the effects of unconventional monetary policy measures such as helicopter money and negative interest rates are under these circumstances. I find that liquidity traps can be caused by a decrease in the bonds-to-money ratio, by a decrease in productivity of capital, or by an increase in demand for consumption. The model shows that, while conventional monetary policy cannot control inflation in a liquidity trap, unconventional monetary policies allow the monetary authority to regain control over the inflation rate, and that an increase in the bonds-to-money ratio is the only welfare-improving policy.

It is an intriguing insight that it all depends on the bonds-to-money ratio, and hence to improve its yield differential goes through negative interest rates on reserves if bond yields are too low.

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