NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Real Balance Effect

Peter N. Ireland

NBER Working Paper No. 8136
Issued in February 2001
NBER Program(s):   ME

This paper extends a conventional cash-in-advance model to incorporate a real balance effect of the kind described by de Scitovszky, Haberler, Pigou, and Patinkin. When operative, this real balance effect eliminates the liquidity trap, allowing the central bank to control the price level even when the nominal interest rate hits its lower bound of zero. Curiously, the same mechanism that gives rise to the real balance effect also implies that monetary policies have distributional consequences that make some agents much worse off under a zero nominal interest rate than they are when the nominal interest rate is positive.

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Document Object Identifier (DOI): 10.3386/w8136

Published: Ireland, Peter N. “The Liquidity Trap, the Real Balance Effect, and the Friedman Rule." International Economic Review (November 2005).

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