Liquidity Traps: A Unified Theory of the Great Depression and Great Recession

Gauti Eggertsson and Sergey Egiev

No 33195, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper presents a unified framework to explain three major economic downturns: the U.S. Great Depression, the U.S. Great Recession, and Japan’s Long Recession. Temporary economic disruptions, such as banking crises and excessive debt accumulation, can drive natural interest rates into negative territory in the short term. At the same time, structural factors, including demographic decline and rising inequality, can depress natural interest rates over short and long horizons. A negative natural interest rate and the zero lower bound (ZLB) are necessary conditions for a liquidity trap. Credible monetary policy can counteract the adverse effects of short-run liquidity traps. Diminished monetary policy credibility or persistent negative natural rates may necessitate fiscal interventions. The framework sheds light on the macroeconomic challenges of low-interest-rate environments and underscores the central importance of policy regimes. We close by reflecting on the great macroeconomic question of our time: Will short-term interest rates collapse back to zero once the inflation surge of the 2020s moves to the back mirror and the political landscape in the US has dramatically changed?

JEL-codes: E0 E52 N12 (search for similar items in EconPapers)
Date: 2024-11
New Economics Papers: this item is included in nep-cba, nep-fdg, nep-his, nep-mac and nep-mon
Note: ME
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