VoxEU Webcast

Stuck in a Liquidity Trap

Stephanie Schmitt-Grohé explains that if interest rates are low and saving rates are high, economies get stuck in a liquidity trap. If interest rates can't fall any further, a central bank has no tool to stimulate the economy. Monetary policy becomes ineffective. “In a liquidity trap, monetary policy is constrained. There’s no policy space left,” explains Schmitt-Grohé. “Inflation is below target, and expected inflation, five or ten years out, is also below target.” Schmitt-Grohé says that inflationary expectations are “unanchored.” People don’t believe that the central bank will be able to meet the inflation target anytime soon and take it that the new normal is a world with inflation lower than the central banks’ commitment.