The US is in a liquidity trap --- Paul Krugman How would we know if Krugman is right? A Keynesian liquidity trap occurs at the point when interest rates become so low that cash balances are passively held regardless of their size. The relationship between interest rates and velocity therefore goes flat at low interest rates, since increases in the money stock simply produce a proportional decline in velocity, without requiring any further decline in yields. The belief that an increase in the money supply will result in an increase in GDP relies on the assumption that velocity will not decline in proportion to the increase in money. Unfortunately for the proponents of quantitative easing, this assumption fails spectacularly in the data - both in the U.S. and internationally - particularly at a zero interest rate. Falling velocity implies that a given stock of money is being hoarded, so that nominal GDP is growing slower than the stock of money. If velocity falls, holding the quantity of money constant, youll observe either a decline in real GDP or deflation. investorsinsight/blogs/thoughts_from_the_frontline/archive/2010/11/05/thoughts-on-liquidity-traps.aspx
Posted on: Sat, 15 Nov 2014 19:10:58 +0000
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