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.
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.
Monetary policy, after all, is less effective near the "zero bound" and in scenarios where other "liquidity trap
" factors are in play.
This impression was false: the market economy, as Keynes would soon point out, naturally suffers from a "liquidity trap
If IS cuts LM in the liquidity trap
region, income changes will not affect interest rates and the earlier presented models hold.
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.
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.
In other words, we are in a liquidity trap
: without an increase in
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.
" 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.
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.
The central bank is using negative deposit rates to try to prevent the money supply that it has created from disappearing into speculators' pockets, a situation which Keynes described as the liquidity trap
, and which makes monetary policy ineffective.