Escaping a Liquidity Trap: Keynes’ Prescription Is Right But His Reasoning Is Wrong

Taiji Harashima

MPRA Paper from University Library of Munich, Germany

Abstract: Keynes’ original intention in introducing the concept of a liquidity trap was to explain the reason why persistent large amounts of unutilized resources were generated during the Great Depression. This paper shows that this type of phenomenon cannot be explained in the framework of a traditional competitive market equilibrium. Instead, it can be understood in terms of a Nash equilibrium consisting of strategies of choosing a Pareto inefficient transition path because a Nash equilibrium can conceptually coexist with Pareto inefficiency. Such a Nash equilibrium will be selected when an upwards time preference shock occurs. At this Nash equilibrium, monetary policies are useless but fiscal policies are very effective as Keynes argued, but for different reasons.

Keywords: Liquidity trap; Monetary policy; Fiscal policy; Pareto inefficiency; Time preference (search for similar items in EconPapers)
JEL-codes: E32 E52 E62 (search for similar items in EconPapers)
Date: 2013-07-08
New Economics Papers: this item is included in nep-mac, nep-mon and nep-pke
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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https://mpra.ub.uni-muenchen.de/69217/1/MPRA_paper_69217.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:48115

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