liquidity trap

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Liquidity Trap

A recession during which banks are unwilling to lend and nominal interest rates are already at or near zero. Because interest rates are so low, the central bank can do nothing further to expand the money supply. At the same time investors are unwilling to invest to help the economy grow because banks are unwilling to lend because their returns are so low. This extends the recession and indeed makes it worse. Many economists believe that the best way to end a liquidity trap is a money gift, where the government directly transfers money to consumers in hopes that they will spend it to spur investment.

liquidity trap

a situation where the INTEREST RATE is so low that people prefer to hold money (LIQUIDITY PREFERENCE) rather than invest it. At low rates of interest, the MONEY DEMAND SCHEDULE becomes infinitely elastic. In these circumstances, any attempt by monetary policy to lower interest rates in order to stimulate more INVESTMENT (see MONEY SUPPLY/SPENDING LINKAGES) will be futile, and will simply result in more money being held. KEYNES argued that in a depressed economy that is experiencing a liquidity trap the only way to stimulate investment is to increase GOVERNMENT EXPENDITURE or reduce TAXES in order to increase AGGREGATE DEMAND and improve business confidence about future prosperity, encouraging people to invest.
References in periodicals archive ?
Yetman, "Capital Controls, Global Liquidity Traps and the International Policy Trilemma," NBER Working Paper No.
In their efforts to fight inflation, central banks keep interest rates high, which effectively created liquidity traps in these economies.
Both have been used more widely -- indeed, taken to extreme levels -- to supplement the unconventional expansion of balance sheets in the context of liquidity traps.
Australian author Dudley Skelley presents Let's Begin Again for the New Millennium, an anthology of 21 socially conscious poems about potential solutions to human problems - especially liquidity traps (scarcity of credit) and environmental issues.
I don't wish to leave the impression that Congdon has completely overlooked the problems raised by liquidity traps.
Goodfriend (2000) and Buiter and Panigirtzoglou (2003) have revived an old proposal by Silvio Gesell for the government to tax money, effectively removing the lower bound on interest rates and therefore eliminating the possibility of liquidity traps.
22) Models with multiple steady states are a natural laboratory for the study of learning issues, independent of questions about liquidity traps.
While not everyone agrees that liquidity traps are a serious possibility, in this Economic Commentary, we assume they are and discuss the merits and the drawbacks of these exchange-rate-based escapes.
In the same way that liquidity traps can be expunged from financial city centres and the free international flight of capital - flight in as well as out - so too can economies in Asia/Pacific help themselves by building in safety factors for future recessions.
Krugman uses slow growth of M2 to infer liquidity traps (except in the United States in 2009), but growth of Japan's M2 plus CDs accelerated modestly from 1993 to 1998 when the monetary base did.
The prevalent thinking about liquidity traps suggests that the perfect substitutability of money and bonds at a zero short-term nominal interest rate renders open market operations ineffective for achieving macroeconomic stabilization goals.
The chapter concludes with interesting discussions of real-balance effects and liquidity traps, Ricardian equivalence, and the role of fiscal policy in generating inflation.