The macroeconomics of financial crises : How risk premiums, liquidity traps and perfect traps affect policy options
Series
Discussion Paper
Type
discussion paper
Date Issued
2009-07-25
Author(s)
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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Language
English
Keywords
financial crisis
credit crunch
liquidity trap
zero lower bound
risk premiums
policy options
fiscal policy
monetary policy
open economy
HSG Classification
contribution to scientific community
Refereed
No
Publisher
Department of Economics, University of St. Gallen
Publisher place
St. Gallen
Number
2009-15
Start page
26
Subject(s)
Division(s)
Eprints ID
55138