Optimal Monetary Policy in a Liquidity Trap with Heterogeneous Agents

Xavier Ragot (1, 2)

1 OFCE - Observatoire français des conjonctures économiques (Sciences Po)
2 ECON - Département d'économie (Sciences Po)

This paper derives the optimal money injection at the Zero Lower Bound (ZLB), in a tractable model where households hold heterogeneous money holdings due to explicit financial frictions, such as limited participation or temporary binding credit constraints. This framework is motivated by recent empirical findings. A deleveraging shock generates deflationary pressure and a fall in the real interest rate, pushing the economy to the ZLB. The main result is that open-market operations can stabilize the economy at the ZLB whereas lump-sum money transfers cannot. Moreover, an optimal money injection does not avoid the economy being at the ZLB.

Keywords: Liquidity trap; Zero lower bound; Heterogeneous agents; Optimal policy

Domains: Economics and Finance

Xavier Ragot. Optimal Monetary Policy in a Liquidity Trap with Heterogeneous Agents. 2017. ⟨hal-03459028⟩