The Real Balance Effect

49 Pages Posted: 22 Feb 2001 Last revised: 27 Mar 2022

See all articles by Peter N. Ireland

Peter N. Ireland

Boston College - Department of Economics

Date Written: February 2001

Abstract

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.

Suggested Citation

Ireland, Peter N., The Real Balance Effect (February 2001). NBER Working Paper No. w8136, Available at SSRN: https://ssrn.com/abstract=261261

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