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Wednesday, April 22 • 10:45am - 11:05am
Liquidity Trap and Quantitative Easing: Adapting the ISLM

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The burst of the real estate bubble and subsequent financial crisis that began in the US in 2008 prompted the Federal Reserve’s Open Market Committee (FOMC) to reduce the target for the Federal Funds Rate to nearly zero in order to keep banks liquid and stave off a severe financial crisis. However, loosening of monetary policy via the Federal Funds Rate is ineffective beyond this zero bound, as nominal interest rates cannot be negative. In order to prevent a severe recession or depression, the Federal Reserve turned to unconventional monetary policy to influence macroeconomic conditions via a regime of asset purchases to reduce long term interest rates. Traditionally, the Investment/Savings Liquidity Model (ISLM), developed by John Hicks in 1937, provides suggestions as to where the equilibrium for the money market lies with regards to the supply of money, represented by the LM curve, and the expected interest rate, dictated by the investment/savings curve which shapes demand. However, as the interest rate approaches zero, the traditional model loses efficacy in describing the interrelations of the aforementioned factors, thus necessitating a reexamination of the model. Here, we intend to adapt the ISLM model to accurately describe the liquidity trap that exists when nominal interest rates reach the zero lower bound, as well as how unconventional monetary policy measures can be represented in the ISLM using Japan and the United States as case studies.


Wednesday April 22, 2015 10:45am - 11:05am PDT
016 Karpen Hall

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