17 April 2011
Paul Krugman and the liquidity trap
I thought Paul Krugman was the only senior economist afflicted by the scourge of the liquidity trap. But apparently the disease is catching. The New Yorker
quotes Larry Summers as saying this month that while searching for insights about what to do in a debt crisis, "I was heavily influenced by the basic I.S.L.M. framework augmented to take account of liquidity traps." In what follows I offer an effective vaccine against the liquidity trap. But of course if people decline to be vaccinated ... [shrug shoulder here].
The liquidity trap thesis originates with what Keynes called the speculative motive for liquidity preference". In Keynes the argument is put somewhat like this. When interest rates are very low, everybody expects them to go up shortly. If this were to happen any bonds they hold would depreciate and they would sustain a loss. Therefore there is a general tendency to opt out of bonds and instead hold cash.
Read the whole article