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Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy

Author

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  • Gaël Giraud

    (Agence Française de Développement)

  • Antonin Pottier

    (PSL Research University)

Abstract

This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, durable goods and default. Short positions in long-term loans are backed by collateral, the value of which depends on monetary policy. The Quantity Theory of Money turns out to be compatible with long-run non-neutrality of money. Moreover, we show that, provided it does not lead to a liquidity trap, an expansionary monetary policy reduces markets’ inefficiency. Finally, we prove that, as the quantity of Bank money injected in the economy grows to infinity, only three scenarios can asymptotically emerge: (1) either the economy enters a liquidity trap in the first period, because the monetary expansion is not credible; (2) or a credible expansionary monetary policy accompanies the orderly functioning of markets at the cost of fueling inflation on the commodity market; (3) else, the money injected by the central bank increases the leverage of indebted investors, fueling a financial bubble whose bursting may lead to debt-deflation in the next period. This dilemma of monetary policy highlights the default channel affecting trades and production and provides a rigorous foundation to Fisher’s debt-deflation theory as being distinct from Keynes’ liquidity trap. It sheds some light on the pros and contrast of non-conventional monetary policies.

Suggested Citation

  • Gaël Giraud & Antonin Pottier, 2016. "Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(1), pages 383-408, June.
  • Handle: RePEc:spr:joecth:v:62:y:2016:i:1:d:10.1007_s00199-015-0914-7
    DOI: 10.1007/s00199-015-0914-7
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    Cited by:

    1. varelas, erotokritos, 2013. "A Comment on Chicago Rule, Chicago School, and Commercial Bank Seigniorage," MPRA Paper 48770, University Library of Munich, Germany.
    2. Gaël Giraud & Antonin Pottier, 2016. "Debt-deflation versus the liquidity trap: the dilemma of nonconventional monetary policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(1), pages 383-408, June.
    3. Maxime Menuet & Alexandru Minea & Patrick Villieu, 2018. "Deficit, monetization, and economic growth: a case for multiplicity and indeterminacy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 65(4), pages 819-853, June.
    4. Giraud, Gaël & Grasselli, Matheus, 2021. "Household debt: The missing link between inequality and secular stagnation," Journal of Economic Behavior & Organization, Elsevier, vol. 183(C), pages 901-927.
    5. Gaël Giraud & Matheus GRASSELLI, 2017. "The macrodynamics of household debt, growth, and inequality," Working Paper c15af656-d7a4-485c-867f-5, Agence française de développement.
    6. Bovari, Emmanuel & Giraud, Gaël & Mc Isaac, Florent, 2018. "Coping With Collapse: A Stock-Flow Consistent Monetary Macrodynamics of Global Warming," Ecological Economics, Elsevier, vol. 147(C), pages 383-398.
    7. Gaël Giraud & Florent MCISAAC & Emmanuel BOVARI & Ekaterina ZATSEPINA, 2017. "Coping with the Collapse: A Stock-Flow Consistent Monetary Macrodynamics of Global Warming. Updated version: January 2017," Working Paper b6f3f098-ed24-44bf-9cdd-1, Agence française de développement.
    8. Maciej Ryczkowski, 2021. "Money and inflation in inflation-targeting regimes – new evidence from time–frequency analysis," Journal of Applied Economics, Taylor & Francis Journals, vol. 24(1), pages 17-44, January.
    9. Soldatos, Gerasimos T. & Varelas, Erotokritos, 2014. "The Chicago Tradition and Commercial Bank Seigniorage," MPRA Paper 57721, University Library of Munich, Germany.
    10. Erotokritos Varelas & Gerasimos T. Soldatos, 2014. "The Chicago Tradition and Commercial Bank Seigniorage," Research in World Economy, Research in World Economy, Sciedu Press, vol. 5(1), pages 29-38, March.

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    More about this item

    Keywords

    Central bank; Liquidity trap; Quantitative easing; Collateral; Default; Debt-deflation;
    All these keywords.

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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