Investment and liquidity trap. Monetary policy of the state

A liquid trap is a situation described by representatives of the Keynesian school of economics, when the infusion of cash into the banking system by the state can not reduce the interest rate. That is, it is a separate case when monetary policy proves to be ineffective. The main reason for the emergence of liquid traps are negative consumer expectations, which force people to save most of their income. This period is well characterized by "free" loans with almost zero interest rates, which in no way affect the price level.

The concept of liquidity

Why do many prefer to keep their savings in cash, rather than buying, for example, real estate? It's all about liquidity. This economic term denotes the ability of assets to be sold quickly at a price close to the market price. Absolutely liquid assets are cash. They can immediately buy everything you need. The money in bank accounts is somewhat less liquid. The situation with bills and securities is more complicated. In order to buy something, they must first be sold. And here it is necessary to decide what is more important for us: as close as possible to their market price or do everything quickly.

Next is accounts receivable, stocks of goods and raw materials, machinery, equipment, buildings, constructions, unfinished construction. However, one must understand that the money that is hidden at home under the mattress does not bring any income to their owner. They just lie and wait for their time. But this is a necessary payment for their high liquidity. The level of risk is directly proportional to the amount of possible profit.

What is a liquid trap?

The original concept is related to the phenomenon, which was expressed in the absence of a reduction in interest rates with an increase in the money supply in circulation. This completely contradicts the IS-LM model of monetarists. Typically, central banks reduce interest rates in this way. They buy bonds, creating an influx of new cash. Keynesians see here the weakness of monetary policy.

When there is a liquid trap, a further increase in cash in circulation does not have any impact on the economy. This situation is usually associated with a low interest on bonds, as a result of which they become equivalent to money. The population seeks not to meet their ever-growing needs, but to accumulation. This situation is usually associated with negative expectations in society. For example, on the eve of a war or during a crisis.

Causes

At the beginning of the Keynesian revolution in the 1930s and 1940s, various representatives of the neoclassical trend tried to minimize the impact of this situation. They argued that a liquid trap is not proof of the inefficiency of monetary policy. In their opinion, the whole point of the latter is not to lower interest rates to stimulate the economy.

Don Patinkin and Lloyd Metzler drew attention to the existence of the so-called Pigou effect. The stock of real money, as scientists have argued, is an element of the function of aggregate demand for goods, so it will directly affect the investment curve. Therefore, monetary policy can stimulate the economy even when it is trapped in liquidity. Many economists deny the existence of the Pigou effect or speak of its insignificance.

Criticism of the concept

Some representatives of the Austrian school of economics reject Keynes's theory of the preference for liquid monetary assets. They draw attention to the fact that the lack of investment in a certain period is compensated by its excess in other time intervals. Other schools of economics highlight the inability of central banks to stimulate a national economy with a small price for assets. Scott Sumner is generally against the idea of the existence of the situation in question.

Interest in the concept resumed after the global financial crisis, when some economists believed that to improve the situation, direct cash inflows into households are needed.

Investment trap

This situation is similar to the one discussed above. The investment trap is expressed in the fact that the IS line on the chart occupies a completely perpendicular position. Therefore, the shift of the LM curve can not change the real national income. To print money and invest them in this case is completely useless. This trap is due to the fact that the demand for investment can be completely inelastic at a rate of interest. Eliminate it with the help of the "property effect".

In theory

Neoclassicists believed that the increase in the money supply still stimulates the economy. This is due to the fact that uninvested resources will once be invested. Therefore, it is still necessary to print money in crisis situations. This was the hope of the Bank of Japan in 2001, when it launched a policy of "quantitative easing".

Similarly, the authorities of the United States and some European countries argued during the global financial crisis. They tried not to give out free loans and further lower interest rates, but to stimulate the economy by other methods.

On practice

When the protracted period of stagnation began in Japan, the concept of a liquid trap again became relevant. Interest rates were almost zero. At that time, no one had ever guessed that over time banks in some Western countries would agree to give $ 100 on loan and get back a smaller amount. Keynesians considered low, but positive interest rates. However, to date , economists are considering a liquidity trap due to the existence of what is called "free loans". The interest rate on them is very close to zero. So there is a liquid trap.

An example of such a situation is the global financial crisis. During this period interest rates on short-term loans in the US and Europe were very close to zero. Economist Paul Krugman said that the developed world is in a liquid trap. He noted that the tripling of the money supply in the US for the period from 2008 to 2011 had no significant effect on the price level.

Solution

The view that monetary policy at low interest rates can not stimulate the economy is quite popular. He is defended by such famous scientists as Paul Krugman, Gauti Eggertsson and Michael Woodford. However, Milton Friedman, the founder of monetarism, did not see any problems in low interest rates. He believed that the central bank should increase the supply of money, even if they are zero.

The state must continue to buy bonds. Friedman believed that central banks can always force consumers to spend their savings and provoke inflation. He used an example with an airplane that drops dollars. Households collect them and put them in equal piles. This situation is possible in real life. For example, the central bank can directly finance the budget deficit. I agree with this point of view and Willem Buiter. He believes that direct cash inflows can always increase demand and inflation. Therefore, monetary policy can not be considered ineffective, even in conditions of a liquid trap.