NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Liquidity Trap and the Pigou Effect: A Dynamic Analysis with Rational Expectations

Bennett T. McCallum

NBER Working Paper No. 894 (Also Reprint No. r0477)
Issued in May 1982
NBER Program(s):   EFG

A Keynesian idea of considerable historical importance is that, in the presence of a liquidity trap, a competitive economy may lack--despite price flexibility--automatic market mechanisms that tend to eliminate excess supplies of labor. The standard classical counterargument, which relies upon the Pigou effect, has typically been conducted in a comparative-static framework. But, as James Tobin has recently emphasized, the more relevant issue concerns the dynamic response (in "real time") of an economy that has been shocked away from full employment. The present paper develops a dynamic analysis, in a rather standard model, under the assumption that expectations are formed rationally. The analysis permits examination of Tobin's suggestion that, because of expectational effects, such an economy could be unstable. Also considered is Martin J. Bailey's conjecture that, in the absence of a stock Pigou effect, Keynesian problems could be eliminated by expectational influences on disposable income.

download in pdf format
   (196 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w0894

Published: McCallum, Bennett T. "The Liquidity Trap and the Pigou Effect: A Dynamic Analysis with Rational Expectations." Economica, Vol. 50, No. 200, (November 1983), pp. 395-405. citation courtesy of

 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us