Friday, April 29, 2011

A Liquidity Trap is a Liquidity Trap

Mark Thoma post Paul Krugman’s column today in the NYT castigating the Fed for not doing more to help the unemployed.

Now Krugman is unquestionably the best and brightest.  However, with respect to monetary policy he has two themes.  One is that the U. S. is in the classic liquidity trap and the second is that the Bernanke and the Fed need to do more to stimulate the economy.

These two positions are self-contradictory.  A monetary trap means that monetary policy cannot be effective, that increasing the money supply and bank reserves just increases liquidity and holdings.  Krugman’s conclusion is that the Fed is hesitant to act because of the anti-Fed position of Rep. Ron Paul (R, Tx) who is now in a position of authority.  This is incorrect, the Fed simply can do no more.

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