When the economy weakens, central banks respond by lowering interest rates to encourage borrowing and spending. But recent large downturns, such as the Great Recession and Japan’s Long Recession, have highlighted a major limitation of this tool—the zero lower bound. In such extreme circumstances, the economy can get stuck in what economists call a liquidity trap.
In a paper in the Journal of Economic Literature, authors Gauti B. Eggertsson and Sergei K. Egiev offer a unified theoretical framework for understanding liquidity traps. The authors argue that for fast-moving forces that quickly drive interest rates down, such as banking crises, government budgets and public expectations play a key role. They examine these forces in the largest economic downturn in US history—the Great Depression.
Πηγή: www.aeaweb.org/