Chapter 4 considers economies with borrowing constraints. This assumption is motivated by the observation that monetary expansions after the Great Recession did not entail inflation in the expected manner. At the same time, nominal and real interest rates tended to decline in many advanced economies. The text offers an in-depth analysis of credit crunches, liquidity traps, and interest rates at the zero lower bound and demonstrates that borrowing constraints help reconcile theory and evidence. According to the key insight, a binding borrowing constraint detaches money creation from credit creation. In this case, inflation ceases to be a monetary phenomenon, as in standard models, but becomes a credit phenomenon. This finding explains why expansionary monetary policies failed to produce inflation since the Great Recession.
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