Monetary Policy Inertia, Macroprudential Policy, and Financial Stability in a Liquidity Trap

After the colossal financial crisis of 2008, many monetary policy analyses have shown the profound implications for financial stability of monetary policy in a liquidity trap. This paper investigates how monetary policy in a liquidity trap affects financial stability in a New Keynesian model incorporating a financial friction. The main findings are as follows: A strong financial stabilization policy is effective in mitigating an excess expansion of credit in normal times. However, this same stabilization policy expands credit when the economy is in a liquidity trap. These findings show that the effectiveness of financial stabilization policy can vary depending on whether or not the economy is in a liquidity trap