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.

Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005

Mentioned in

References in periodicals archive

Europe and Japan are currently caught in what might be called a monetary black hole -- a liquidity trap in which there is minimal scope for expansionary monetary policy.

Whither central banking?

One interesting auxiliary finding is that the tightening of balance sheet constraints on household borrowers not only reduces household spending, it also pushes down interest rates, helping account for how household financial distress could move the economy into a liquidity trap, where the zero lower bound on the nominal interest rate binds.

Economic Fluctuations and Growth

Monetary policy, after all, is less effective near the "zero bound" and in scenarios where other "liquidity trap" factors are in play.

How Western economies can avoid the Japan trap

This impression was false: the market economy, as Keynes would soon point out, naturally suffers from a "liquidity trap."

KEYNES'S LAST STAND

If IS cuts LM in the liquidity trap region, income changes will not affect interest rates and the earlier presented models hold.

The Harrod-Domar Model in a Keynesian Framework

Third, central banks are all but powerless to cope with the moving target of what can be called a non-stationary liquidity trap. First observed by John Maynard Keynes during the Great Depression of the 1930s, the liquidity trap describes a situation in which policy interest rates, having reached the zero bound, are unable to stimulate chronically deficient aggregate demand.

Central banks have used up all ammo on inflation

This of course masked what he actually contributed, which was mainly the long-run underemployment equilibrium (i.e., the thesis that involuntary unemployment could exist in a market economy even with flexible wage rates) and his interest-determining theory of liquidity preference and the liquidity trap. Both dealt irreparable harm to the older view of the market, in particular the latter.

The Consequences of Keynes

In other words, we are in a liquidity trap: without an increase in

Canada, United States, and European Union - out of sync on trade agreements? Or are we sympatico?

The latest country to join the party was Japan, which has been struggling with the ineffective impact of expansionary monetary policy for more than two decades, a concept known as the liquidity trap. The Bank of Japan cut rates on new bank reserves to -0.1 percent in January this year, hoping this will show companies and individuals its seriousness in battling deflation.

Negative interest rates

"LIQUIDITY TRAP" Total social financing (TSF), a broad measure of credit and liquidity in the economy, jumped to 1.47 trillion yuan in August from 487.9 billion yuan in July.

China's bank lending surges to $142.23bn

Tariff protection may not be bad macroeconomic policy in a liquidity trap. But this doesn't make it good foreign policy - for Trump or anyone else.

WHAT'S THE PROBLEM WITH PROTECTIONISM