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A Model of U.S. Monetary Policy Before and After the Great Recession

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  • David Andolfatto

Abstract

The author studies a simple dynamic general equilibrium monetary model to interpret key macroeconomic developments in the U.S. economy both before and after the Great Recession. In normal times, when the Federal Reserve?s policy rate is above the interest paid on reserves, countercyclical monetary policy works in a textbook manner. When a shock drives the policy rate to the zero lower bound, the economy enters a liquidity-trap scenario in which open market purchases of government securities have no real or nominal effects, apart from expanding the supply of excess reserves in the banking sector. In a liquidity trap, the Fed loses all control of inflation, which is now determined entirely by the fiscal authority. In normal times, raising the interest paid on reserves stimulates economic activity, but in a liquidity trap, raising the interest paid on reserves retards economic activity.

Suggested Citation

  • David Andolfatto, 2015. "A Model of U.S. Monetary Policy Before and After the Great Recession," Review, Federal Reserve Bank of St. Louis, vol. 97(3), pages 233-256.
  • Handle: RePEc:fip:fedlrv:00045
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    References listed on IDEAS

    as
    1. Andolfatto, David, 2003. "Monetary Implications of the Hayashi-Prescott Hypothesis for Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 21(4), pages 1-20, December.
    2. Andolfatto, David & Williamson, Stephen, 2015. "Scarcity of safe assets, inflation, and the policy trap," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 70-92.
    3. Roger E.A. Farmer, 2013. "Animal Spirits, Financial Crises and Persistent Unemployment-super-," Economic Journal, Royal Economic Society, vol. 0, pages 317-340, May.
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    Cited by:

    1. Andolfatto, David & Martin, Fernando M. & Zhang, Shengxing, 2017. "Rehypothecation and liquidity," European Economic Review, Elsevier, vol. 100(C), pages 488-505.
    2. Bacchetta, Philippe & Benhima, Kenza & Kalantzis, Yannick, 2020. "Money and capital in a persistent liquidity trap," Journal of Monetary Economics, Elsevier, vol. 116(C), pages 70-87.
    3. Jia, Pengfei, 2020. "Negative Interest Rates on Central Bank Digital Currency," MPRA Paper 103828, University Library of Munich, Germany.
    4. Lukas Altermatt & Kohei Iwasaki & Randall Wright, 2023. "General Equilibrium with Multiple Liquid Assets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 267-291, December.
    5. Chien-Chiang Wang, 2023. "Asset Market Frictions, Household Heterogeneity, and the Liquidity Theory of the Term Structure," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 67-99, January.
    6. Marieh Azizirad, 2022. "Fisher vs Keynes: Does an Interest Rate Hike Cause Inflation to Increase or Decrease?," Discussion Papers dp22-08, Department of Economics, Simon Fraser University.
    7. David Andolfatto, 2018. "Reconciling Orthodox and Heterodox Views on Money and Banking," Review of Economic Analysis, Digital Initiatives at the University of Waterloo Library, vol. 10(4), pages 351-370, November.
    8. Lucas Herrenbrueck, 2019. "Interest Rates, Moneyness, and the Fisher Equation," Discussion Papers dp19-01, Department of Economics, Simon Fraser University.

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    More about this item

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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