Is this grandma’s liquidity trap?

I say no and David Andolfatto agrees:

In grandma’s liquidity trap, the real interest rate is too high because of the zero lower bound. Steve [Williamson] argues that in our current liquidity trap, the real interest rate is too low, reflecting the huge world appetite for relatively safe assets like U.S. treasuries.

If this latter view is correct, then “corrective” measures like expanding G or increasing the inflation target are not addressing the fundamental economic problem: low real interest rates as the byproduct of real economic/political/financial factors.

I remain surprised at how many policy discussions fail to draw this basic distinction.

Hat tip goes to Mark Thoma.


but expanding G means expanding the supply of safe assets, no? you increase spending and finance it by issuing treasuries. i thought that was the whole point. (ok, maybe not the whole point, as most of the talk has focused on spending multipliers, but certainly a big part of the point)

It is also possible to expand the supply of safe assets by cutting T. Just a reminder to those who are wedded to G.

besides, as david beckworth has repeatedly argued, if the Fed is succesful in raising expectations of nominal GDP, then the private sector will also want to go in debt to finance investment for future production (that is, it will increase the supply of private safe assets)

Tyler seems surprised a lot.

Unllike his readers.

Seriously, we should borrow more money expressly to manufacture more safe assets? That's a recipe for a U.S. balance of payments crisis and the mother of all global financial crises.

The world does need more safe assets, but they shouldn't be (overwhelmingly) issued by a single country, denominated in a single currency. Large current account deficits (and the dollar overvaluation they imply) create large distortions in our economy (like housing bubbles, or government malinvestment). What we should be aiming for is a tri-polar world, where safe assets are generated by the U.S., Europe, and China.

Ah crap, I just made the mistake of commenting on the wrong blog; I should have commented on the linked article's blog page. I somehow doubt Tyler Cowen believes the U.S. should go into even more debt simply to generate FX reserves.

Functional finance

Does the world *need* more safe assets, or does it merely *want* more safe assets? Maybe it's time for the world to acknowledge that even "safe" assets are not all that safe, and start managing risk. It's not such a huge leap to start assuming that the risk-free rate is zero, rather than the yield on US gov't bonds, notes, and bills. Serious question: are you aware of any reason the world would stop functioning if all risk-free assets were gone overnight, other than a whole lot of lazy fixed-income managers throwing hissy fits? I mean, yeah, positive (the higher the better!) risk-free rates are nice to have, but so is perpetuum mobile...

We're a long way from the 2008 panic. The stock market is hitting new highs, junk bonds are selling briskly, and asset managers are complaining that they can't find any mispriced assets.

I just don't see any reason to believe in this "safe asset shortage" theory. It makes less and less sense every day.

If that is true I have some Euro denominated bonds I'd like to sell you at par...

Great link. I often struggle with esoteric economic conversations, but this had none of that.

Seems to me to be a distinction without a difference. Interest rates are too low because demand is too low and interest rates are too high because demand is too low. More demand in the economy creates more demand for money which raises interest rates and more demand in the economy lowers risk on private investment and moves money from public to private investment.


I read David Andolfatto's blog, who references Stephen Williamson's blog, who both reference Nobel Prize winner Paul Krugman's blog, and I conclude the arguments of the first two are specious, besides being convoluted. It's a sleight of hand that some professors in science use when at the blackboard, and the audience is too dumb to notice. Not that I agree with Krugman's solution of printing more money to solve things, but it's plausible that indeed the funk we're in is simply due to to fear of spending and investing due to various reasons--i.e., lack of Aggregate Demand.

someone else is skeptical:

What is the mechanism by which low interest rates, caused by a large influx of capital, reduces economic growth? Is our production function a decreasing function of capital?

The fact that the US is running a persistent trade deficit and experiencing significant net capital inflows seems like very strong evidence that we are not in a traditional Keynesian situation, where we have 'excess saving.'

If we have excess saving, why are we having a capital inflow rather than a capital outflow?

If combined private and public demand were below the economy's productive capacity, why are we running a trade deficit? Doesn't the existence of a persistent trade deficit indicate that our demand is in excess of our supply?

Very much not our grandma's recession.

A trade deficit indicates that foreign demand for United States financial assets is larger than US demand for foreign financial assets.

It indicates that *net* foreign demand for US assets is greater than *net* US demand for foreign assets. Net demands depend on both the supply and demand of course.

Taking PGL's framework below, which I take to be a 'loanable funds' market, PGL and others seem to be asserting that the intersection of the supply of national savings and the demand for loanable funds is at an interest rate below zero. Therefore, because of the zero lower bound, at nominal interest rates = 0, we have quantity of national saving > demand for loanable funds. So we have excess saving.

But if we have excess saving, we should have net capital outflow. And that is what we see in the case of Japan. Japan is a good match for the classic Keynesian liquidity trap. Japan is grandma's liquidity trap.

But in the US, we don't in fact have that. We have net capital inflow. So the US is not a good match for the classic Keynesian liquidity trap. US is not grandma's liquidity trap.

I'm not saying it's not a liquidity trap. But it's not grandma's liquidity trap.

Let me think: So, the safe rate is low, so we're not in a liquidity trap. Must be everybody is still scared out of their brains, apparently for good reason. In a sophisticated Keynesian Model, which nobody knows anymore, nominal wage changes are equivalent to money supply increases, so labor market problems, which exist, are off the main macro table. Reestablishment of trust will take more years. Until then, I conclude monetary policy is still too tight. Concluded that in 2008 or so. :-)

But monetary policy was too loose from 2003 to 2007, and it is even looser now. The low rate exists because the Fed is buying the majority of long-term debt. The demand for "safe assets" comes from the central bank itself, which cannot print money, only monetize debt.

What people who want looser monetary policy need to admit/realize is that we don't need more debt, we need more fiat money (if you take this line of argument). Which means the Treasury needs to create $500 and $1000 bills and fire up the printing presses, because they need to print about $5-10 trillion in physical cash to get inflation going. They literally do not have the printing capacity at this time to generate inflation.

They literally do not have the printing capacity at this time to generate inflation.

That statement is very wrong.

Almost everyone, except G, is deleveraging. (L1) (Corporations are taking out debt but their balance sheets aren't getting worse because they're sitting on the cash.) G doesn't want to lose elections, therefore G will do the opposite and lever up to offset the contraction. Leaving aside whether or not G is smarter than the combined intelligence of the financial, consumer and corporate sectors of the economy, according to supporters of G there is no marginal cost to debt. The private market disagrees and is saying there are marginal gains from reducing debt.

If you were an evil libertarian this is an ingenius plot: the sucker is USG and its creditors. If you want to reach peak hate of government, this is the best way to do it.

I fail to see how an inflow of capital driven by a demand for safe assets can create a unemployment unless the Fed fails to maintain ngdp growth, i.e. keeps monetary policy too tight, as it did in 2008-12 is apparently still doing. And given that monetary policy failure, increasing G by investments yielding returns greater than the virtually zero interest rate and decreasing T to induce the private sector to do the same would be the proper ("Keynesian") corrective. Sounds very much like great grandma's recession to me.

don't look any further than to German chemicals manufacturer Henkel and what they did with their balance sheet since 2008:
money for this very profitable company would be virtually free yet they have been paying down debt for years. In an interview with a German newspaper these days, the CEO was even bragging about that his company is now "debt free". This will probably not hold for long since he was also eyeing takeover targets which would then be funded by debt again yet currently a lot of people including high level managers are plain and simple afraid of debt. Henkel itself would be quite a safe asset but now they are actually in search for safe assets themselves.

While it would be best if the government would now load up on debt to soak up the funds firms and household want to save, in Europe even the governments are afraid of (more) debt. If it weren't for a couple of still capital hungry developing countries, we would have a full fledged 30s style depression.

Your position that the interest rate currently is too low is missing the fundamental facts here as noted by both Brad DeLong and Paul Krugman. Simply put - with the current level of national savings and investment, the natural rate of interest would have to be negative in order to get back to full employment. But somehow you et al. seemingly have made the silly mistake of movements along a savings schedule when the real issues is that the entire schedule shifted outwards. Most freshmen who make this mistake in Econ 101 tend to get low grades.

Well Swiss banks for a while were giving negative interest rates, so it's not impossible. After all insurance companies with lots of cash are not going to start stuffing mattresses with money. So negative interest is not unthinkable--so much for your model.

I'll put it another way. In most countries the cost structures eat up return while taking on the normal risks of an enterprise that actually does economic activity. You can get the same return by means of sovereign debt issuance, along with the security that supposedly is attached. The capital ends up being spent on pensions and hip replacements, not on a business investment.

This crisis won't be over until there is nothing left to lose.

On the original post Alexander Hamilton notes:

> The demand for safe assets is declining, for the price of Gold, of which the little three dream as the sole bench mark or standard, is down, well past a "correction."

Does the decline in gold prices contradict this idea of the interest rate being too low?


Does gold appear to be a safe asset to you? Take a look at its price volatility.
And ask whether gold is widely accepted as collateral in lending arrangements, the way that UST are.

You are right. All the pro-gold advertising has me brainwashed.

I'm not sure Andolfatto is interpreting Williamson's argument correctly...

I sense a Noah post on the subject soon. Take it easy on me Noah... ;)

In Grandma's liquidity trap the real interest rate ought to have been positive, so if it needed to go negative then it was too low. Policies producing recovery would have made the (long-term, at least) rate go up.

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