Neo-Fisherian Policies and Liquidity Traps

Abstract

Liquidity traps can be either fundamental or confidence-driven. In a simple, unified New Keynesian framework, I provide the analytical condition for the latter’s prevalence: enough shock persistence and endogenous intertemporal amplification of future (“news”) shocks, making income effects dominate substitution effects. The same condition allows neo-Fisherian effects (expansionary-inflationary interest rate increases), which are thus inherent in confidence traps. Several monetary and fiscal policies (forward guidance, interest rate increases, public spending, labor tax cuts) have diametrically opposed effects according to the trap variety. This duality provides testable implications to disentangle between trap types; that is essential, for optimal policies are also conflicting across trap varieties. (JEL E12, E31, E32, E43, E52, E62)