Should we worry about liquidity traps?

Well, short-term T-Bill rates were very close to zero yesterday.  But I’ve long felt that the liquidity trap argument is overrated in its import.  Here is my previous post on the topic.  (As you may know, I don’t like "re-runs" but I’ve received many requests for this.)  Here’s one bit from the post:

Open market operations, when tried, seem to have worked in 1932.
Was Japan in a liquidity trap in the 1990s?  They could have printed
more money and given it to me.  With an interpreter at my side, I would
have spent it right away.  Who knows, maybe you could have helped me.
Here is a good critique of Krugman on Japan.

…What is the evidence for a liquidity trap?  Low nominal rates and the
absence of a recovery?  That’s not much evidence.  I suspect real
coordination problems are at fault in most of these settings, and
hoarding is at most a secondary issue.  Few serious economic problems
are purely monetary in nature, yet the liquidity trap encourages us to
embrace that dangerous idea.

By the way, some sources (now verified) claim that Treasuries "traded negative" for a brief while yesterday.  T-Bills are standard collateral for many kinds of transactions, so for very brief periods of time they can have a shadow value higher than that cash, even apart from the possibility of earning a nominal interest rate.

The liquidity trap is most likely a problem when the Fed is restricted to open market operations, namely trying to trade cash for T-Bills.  A less orthodox Fed (and yes, that is what we have) has many ways around the trap, if indeed it was ever a trap in the first place.


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