Monetary policy: Why is the liquidity trap?

Posted: October 21, 2013 in economy
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CREDIT where credit is due; Paul Krugman anticipated this where many others did not:Since late 2007 the monetary base has risen more than 300 percent, while GDP and consumer prices have risen less than 20 percent. And no, the disconnect is not all due to the 0.25 percent interest rate the Fed pays on reserves.Huge growth in a central bank’s balance sheet need not imply runaway inflation. But it seems strange to me to pivot from that understanding to the broad claim that Milton Friedman misdiagnosed the Great Depression:You can argue that the Fed could have done more — it could have expanded its balance sheet even further, and/or moved into riskier assets, and/or done more to change expectations. But I don’t see how you can deny that making monetary policy effective has been far harder since we hit the ZLB than it was before, and that this retroactively casts great doubt on Friedman’s claims that the Fed could easily have prevented the Great Depression.Wait, wait, wait. No, it doesn’t. There is a school of thought that one might call “naive Friedmanism”, in which money supply growth is the only monetary variable that matters, and it’s easy enough to find examples of cases where that doesn’t pan out. But identifying that as the main contribution of “A Monetary History” or of Friedman’s monetary economics work more generally strikes me as profoundly unfair. Friedman …

via Economic Crisis


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