The Non-Zero Lower Bound Lending Rate and the Liquidity Trap

Khemraj, Tarron (2011): The Non-Zero Lower Bound Lending Rate and the Liquidity Trap.

Abstract

Most studies of the liquidity trap emphasize the zero bound benchmark policy rate. This paper integrates a non-zero lower bound lending rate and the traditional zero bound policy rate in a dynamic structural macroeconomic model that takes into consideration aggregate bank liquidity preference as a financial friction. The approach allows for analyzing the dynamic effects of quantitative easing and an interest rate policy. Once the non-zero lower limit is reached, increasing the benchmark policy rate marginally can have a positive effect on output. Expanding quantitative easing at the non-zero lower limit results in a negative effect on output. Increasing marginally the zero bound policy rate is better at stimulating inflation than quantitative easing. However, excessive tightening in a normal regime would result in the opposite effect.

• Item Type: MPRA Paper
• Language: English
• Keywords: liquidity trap, quantitative easing, financial friction, excess liquidity
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E0 - General > E00 - General; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General

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