Is it possible to identify the type of liquidity trap?
In this paper Cuba-Corda and Singh use a New Keynesian model where the representative agent’s intertemporal Euler equation is modified so that the steady state features a negative relation between output and real interest rate. This modification breaks the tight connection between the natural interest rate and the discount factor, and allows for the possibility of a permanently negative natural interest rate. A key feature of their model is that they allow agents to expect persistent stagnation with ZLB episodes of undefined duration. As a result their framework incorporates two hypotheses of persistent ZLB episodes: expectations-driven liquidity traps and secular stagnation driven liquidity traps.
Can a policy makers understand the type of liquidity trap an economy is experiencing?
They estimate the model using Japanese data from 1998:Q1-2012:Q4, a period in which interest rates remained near zero and find that a policymaker faces considerable real-time uncertainty in identifying the dominant narrative. In view of this uncertainty they outline the need for a robust policy such as appropriate price indexation rules which can increase output under secular stagnation and also eliminate the expectations-driven trap.
Understanding Persistent ZLB: Theory and Assessment
Authors: Pablo Cuba-Borda, Sanjay R. Singh
From: Federal Reserve Board, University of California, Davis
