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The macroeconomics of financial crises : How risk premiums, liquidity traps and perfect traps affect policy options

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abstract The paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global economic and financial crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only when interest rates approach zero but at positive and/or rising rates as well; (2) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (3) Near the fringe of liquidity traps, the risk arises of perfect traps, in which neither monetary nor fiscal policy works when used in isolation, but policy coordination is called for; and (4) Massive financial crises in the domestic money market may even destabilize the economy.

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type discussion paper (English)
   
keywords financial crisis, credit crunch, liquidity trap, zero lower bound, risk premiums, policy options, fiscal policy, monetary policy, open economy
   
date of appearance 25-7-2009
series of paper Discussion Paper (2009-15)
publisher Department of Economics, University of St. Gallen (St. Gallen)
page(s) 26
review not reviewed
   
citation Gärtner, M., & Jung, F. (2009). The macroeconomics of financial crises: How risk premiums, liquidity traps and perfect traps affect policy options. Discussion Paper, 2009-15. St. Gallen: Department of Economics, University of St. Gallen.