Quantitative Easing, Functional Finance, and the 'Neutral' Interest Rate
Universidad Complutense de Madrid (UCM)
September 8, 2011
Levy Economics Institute Working Paper No. 685
The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor households, debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from a reduction in the financial cost of servicing the public debt. The efficacy of the channel that allegedly operates through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that a country that issues its own currency can avoid becoming stuck in a structural “liquidity trap,” provided its central bank is willing to monetize the debt created by a strong enough fiscal expansion.
Number of Pages in PDF File: 30
Keywords: Floor System, Debt Monetization, Functional Finance, Policy Coordination, Neutral Interest Rate
JEL Classification: E10, E12, E44, E52, E58working papers series
Date posted: September 8, 2011 ; Last revised: February 7, 2013
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