The Liquidity Trap – What is it and What Does It Look Like

The Mysteries of Economic Jargon Explained – Wow

Economists are frequently heard to talk about the U. S. being in a ‘liquidity trap”. 

What this simply means is that the Federal Reserve System cannot stimulate the economy by increasing the money supply and increasing bank reserves so that more is spent and invested, because financial institutions, businesses and individuals simply hold the additional funds as additional liquidity.

This result of being in a liquidity trap is that the Federal Reserve has done about all it can to stimulate the economy.  The only policy weapon left is fiscal policy, and that weapon is going on the shelf as Congress and the President negotiate as to which of them can contract the economy the most by cutting spending.

Here, from Paul Krugman, is a graph on what the liquidity trap looks like.  For economists, not a pretty picture.

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Mr. Krugman expands further on this topic here.  It is good reading if you really want to know why pessimism is the flavor of the day for The Dismal Political Economist