KRUGMAN THINKING ABOUT THE LIQUIDITY TRAP PDF

Equitable Growth supports research and policy analysis on how strong competition among U. Equitable Growth supports research and policy analysis on how unequal access to care, 21st century work-life policies, and education undermines stable, broad-based economic growth. Equitable Growth supports research and policy analysis on how trends in economic inequality and mobility and changes in the economy have affected the concentration of wealth, income, and earnings, and how these distributional shifts have affected the promise of economic security and opportunity. Equitable Growth supports research and policy analysis on how tax and macroeconomic policies can promote stable and broad-based economic growth. Over some range spending rises more than one-for-one with income. Why should the relationship flatten out at high and low levels?

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But I thought it might be worthwhile to go over this again. So, at this point America and Japan and core Europe are all in liquidity traps: private demand is so weak that even at a zero short-term interest rate spending falls far short of what would be needed for full employment.

Under these circumstances, normal monetary policy, which takes the form of open-market operations in which the central bank buys short-term debt with money it creates out of thin air, have no effect. Well, the reason open-market operations usually work is that people are making a tradeoff between yield and liquidity — they hold money, which offers no interest, for the liquidity but limit their holdings because they pay a price in lost earnings.

So if the central bank puts more money out there, people are holding more than they want, try to offload it, and drive rates down in the process. And a central bank operation that swaps money for debt basically changes nothing. Ordinary monetary policy is ineffective.

That will have to be a subject for another post; but it makes little if any difference. If investors believe that the central bank will keep the pedal to the metal even as the economy begins to recover, this will imply higher inflation than if it hikes rates at the first hint of good news — and higher expected inflation means a lower real interest rate, and therefore a stronger economy.

So the central bank can still get traction if it can change expectations about future policy. You can see in the figure above that the Bank of Japan did just that in the s.

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