Short- and Long-Run Tradeoff Monetary Easing
In this study, we illustrate a tradeoff between the short-run positive and long-run negative effects of monetary easing by using a dynamic stochastic general equilibrium model embedding endogenous growth with creative destruction and sticky prices due to menu costs. While a monetary easing shock increases the level of consumption because of price stickiness, it lowers the frequency of creative destruction (i.e., product substitution) because inflation reduces the reward for innovation via menu cost payments. The model calibrated to the U.S. economy suggests that the adverse effect dominates in the long run.
The Great Recession during 2007–09 prompted many central banks to conduct unprecedented levels of monetary easing. Although this helped in preventing an economic catastrophe such as the Great Depression, many economies have experienced only slow and modest recoveries (i.e., they faced secular stagnation) since then. Japan has fallen into even longer stagnations, namely the lost decades. Firm entry and productive investment have been inactive since the burst of the asset market bubble around 1990 despite a series of monetary easing measures (Caballero et al. (2008)).