Tuesday, March 18, 2008

Liquidity Traps: Myth And Reality

Source: Mish's Global Economic Analysis

"...Milton Friedman On Liquidity Traps

Indeed the current setup is essentially the liquidity trap that Japan fell into. Wikipedia has this (and much more) to say about Liquidity Traps.

'In monetary economics, a liquidity trap occurs when the economy is stagnant, the nominal interest rate is close or equal to zero, and the monetary authority is unable to stimulate the economy with traditional monetary policy tools. In this kind of situation, people do not expect high returns on physical or financial investments, so they keep assets in short-term cash bank accounts or hoards rather than making long-term investments. This makes the recession even more severe, and can contribute to deflation.

Milton Friedman suggested that a monetary authority can escape a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses. This is referred to as a money gift or as helicopter money (this latter phrase is meant to call forth the image of a central banker hovering in a helicopter, dropping suitcases full of money to individuals).

American economist Paul Krugman suggests that what was needed was a central bank commitment to steady positive monetary growth, which would encourage inflationary expectations and lower expected real interest rates, which would stimulate spending.'

Friedman Is Wrong

Milton Friedman is wrong and Japan proved it. Japan's national debt went from nowhere to 150% of GDP and they are still battling the aftermath of deflation for 18 years or more.

Artificially stimulating the economy eventually causes all sorts of problems..."

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