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In short, as interest rates are already zero, they can't be cut any further. Hence something else is needed to stimulate the economy, like infrastructure spending or quantitative easing (and the efficacy of the latter is somewhat questionable in my opinion). Peak oil is not an energy crisis. It is a liquid fuel crisis.
From Wikipedia: "A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence to stimulate economic growth.
Private sector is loaned up. No more (credible) debt takers.
A liquidity trap is caused when people hoard cash because they expect..
The confidence fairy?
..an adverse event such as deflation,
Rotschilds were very handy creating deflation (according to the movie "Money Masters").
This actually suggests that we don't have a liquidity trap. Central bank has lowered interest rates. Mortgages are cheaper than ever. They just can't go below zero.
Also this suggests that lower interest rate to private sector necessary stimulates economic growth. It does not, if the private sector is over-indebted already.
See Paradox of Thrift
Two caveats are added to this criticism. Firstly, if savings are held as cash, rather than being loaned out (directly by savers, or indirectly, as via bank deposits), then loanable funds do not increase, and thus a recession may be caused - but this is due to holding cash, not to saving per se. Secondly, banks themselves may hold cash, rather than loaning it out, which results in the growth of excess reserves - funds on deposit but not loaned out. This is argued to occur in liquidity trap situations, when interest rates are at a zero lower bound (or near it) and savings still exceed investment demand. Within Keynesian economics, the desire to hold currency rather than loan it out is discussed under liquidity preference.
The problem with the Wikipedia articles about economics, unlike the ones about, say, physics, is that the causal chains are not very clear in the mind of the article writers (possibly because the theory itself is broken). There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman
- Jake Friends come and go. Enemies accumulate.
The "liquidity trap," then, is the point where no amount of additional liquidity can reduce borrowing costs.
It's got nothing to do with liquidity, and it's not a trap. It's an operational constraint on the use of interest rate policy in macroeconomic planning. And it should not come as a surprise to anybody, but it repeatedly does, because neoclassical economists have an unhealthy infatuation with irrationally excluding discretionary fiscal and industrial policy from the realm of macroeconomic planning.
...neoclassical economists have an unhealthy infatuation with irrationally excluding discretionary fiscal and industrial policy from the realm of macroeconomic planning.
A financial crisis initiates a sudden flight to safety among bondholders -- widening interest-rate spreads, diminishing the private sector's desire to sell bonds to raise capital and encouraging individuals to save more and consume less as they, too, hunker down. Thus bond prices rise, and interest rates drop. As rates fall, firms see that they can get capital on attractive terms and so issue more bonds; households see the low interest rate earned on their savings and lose some of their desire to save. The market heads toward equilibrium. ... In responding to a small financial disruption, the Federal Reserve can inject more money into the economy by buying bonds for cash, increasing the amount of cash so that even at the lower velocity of money we retain the same volume of spending. This eases the decline in interest rates, spending, employment and production into a decline in interest rates alone. But when rates become so low that there's little difference between cash and short-term government bonds, open-market operations cease having an effect; they simply swap one zero- yielding government asset for another, with their hunger to hold more safe, liquid assets unsatisfied. This is the liquidity trap.
...
In responding to a small financial disruption, the Federal Reserve can inject more money into the economy by buying bonds for cash, increasing the amount of cash so that even at the lower velocity of money we retain the same volume of spending. This eases the decline in interest rates, spending, employment and production into a decline in interest rates alone.
But when rates become so low that there's little difference between cash and short-term government bonds, open-market operations cease having an effect; they simply swap one zero- yielding government asset for another, with their hunger to hold more safe, liquid assets unsatisfied.
This is the liquidity trap.
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