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Macroeconomics in Times of Liquidity CrisesSearching for Economic Essentials$
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Guillermo A. Calvo

Print publication date: 2016

Print ISBN-13: 9780262035415

Published to MIT Press Scholarship Online: May 2017

DOI: 10.7551/mitpress/9780262035415.001.0001

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Liquidity Crunch/Trap: Some Unconventional Output/Employment/Growth Implications1

Liquidity Crunch/Trap: Some Unconventional Output/Employment/Growth Implications1

(p.85) 5 Liquidity Crunch/Trap: Some Unconventional Output/Employment/Growth Implications1
Macroeconomics in Times of Liquidity Crises

Guillermo Calvo

The MIT Press

The chapter shows that a sudden and sufficiently large contraction of bonds' liquidity could generate a fall in output, liquidity trap and price deflation, suggesting that there is no contradiction between Liquidity Crunch and Liquidity Trap, in line with the discussion in Chapter 2. The discussion is based on a simple model in which there are two types of liquid assets: fiat money and liquid bonds (e.g., Asset-Backed securities) under flexible prices. Fiat money is the liquid asset of choice for households, while under normal conditions firms have a preference for bonds. The model is employed to discuss quantitative easing (QE) in exchange for 'toxic' assets, and to show that the loss of bond liquidity could give rise to secular stagnation.

Keywords:   Asset-Backed securities, Liquidity Crunch, Liquidity Trap, Quantitative Easing, Toxic Assets

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