Negative Interest Rate Policy in a Permanent Liquidity Trap

Abstract

Using a dynamic general equilibrium model, this paper theoretically analyzes a negative interest rate policy in a permanent liquidity trap. If the natural nominal interest rate is above the lower bound set by the presence of vault cash held by commercial banks, a reduction in the nominal rate of interest on excess bank reserves can get an economy out of the permanent liquidity trap. In contrast, if the natural nominal interest rate is below the lower bound, then it cannot do so, but instead a rise in the rate of tax on vault cash is useful for doing so.

Keywords: aggregate demand, liquidity trap, negative nominal interest rate, unemployment

JEL Classification: E12, E31, E58