Brad DeLong Doesn't Understand the Liquidity Trap

Increased Liquidity Leads to Increased Liquidity

The usually intelligent and sensible comments of Brad DeLong took a short detour today.  DeLong has written a very good post on the failure of the economic recovery to be, well, an economic recovery

Time to Panic

But then goes on to say that part of the solution is Quantitative Easing III.

Quantitative Easing is the spin term for having the Federal Reserve lower interest rates and increase bank reserves by purchasing government debt, in effect monetizing the debt.  The assumptions behind such a policy are that lower interest rates and more bank reserves will lead to increased commercial lending by banks, thus stimulating the economy.

The only problem with this is that this theory was debunked almost 80 years ago by Keynes.  He described a liquidity trap, a situation in which greater liquidity leads to, well, greater liquidity.  The additional liquidity in the system does not create commercial lending, it creases additional liquidity.  This liquidity is simply held as idle resources.

As far as interest rates are concerned, they are currently so low that any further lowering is just not possible to a great extent, and minimal lowering will not increase the demand for funds.  The demand for funds is determined by an increase in aggregate demand, which is insufficient today, and will be even more insufficient if Conservatives press budget cuts on the Federal Government.

The liquidity trap is a trap, as already denoted by The Dismal Political Economist.  Why is it exactly that since  QE II didn’t work because of the liquidity trap, folks think QE III will?