Liquidity trap and secular stagnation

In this paper we analyze the link between the ZLB and slow growth in a model with heterogeneous agents and explicit money demand. While the model is neoclassical with small shocks, a large deleveraging shock in the spirit of Eggertsson and Krugman (2012) has permanent effects even with flexible prices. It affects supply rather than demand and implies a long-term decrease in potential output and an increase in cash holding. The basic reason is that in a liquidity trap, saving is allocated to cash rather than physical capital. With short-term price stickiness, monetary policy in the form of an expansion in money supply is effective in reducing unemployment in the short-run, but not in affecting the long term output level. An increase in debt may help exiting the ZLB, but it may lower the capital stock because of higher interest rates.