TY  - JOUR
AU  - McCallum,Bennett T.
TI  - The Liquidity Trap and the Pigou Effect: A Dynamic Analysis with Rational Expectations
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 894
PY  - 1984
Y2  - April 1984
UR  - http://www.nber.org/papers/w0894
L1  - http://www.nber.org/papers/w0894.pdf
N1  - Author contact info:
Bennett T. McCallum
Tepper School of Business, Posner 256
Carnegie Mellon University
Pittsburgh, PA 15213
Tel: 412/268-2347
Fax: 412/268-6830
E-Mail: bm05@andrew.cmu.edu
AB  - 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.
ER  -