Falling into the Liquidity Trap: Notes on the Global Economic Crisis

Thomas Michl

Working Papers from Political Economy Research Institute, University of Massachusetts at Amherst

Abstract: This paper examines the underlying structural imbalances leading up to the Great Recession of 2007-2009 from the vantage point of Hyman Minsky’s theory of the liquidity trap. The traditional approach to the liquidity trap focuses on the zero interest rate boundary, while Minsky’s theory focuses on three conditions that make investment spending unresponsive to monetary policy: low underlying ex post profitability of capital, weak expectations about future profitability, and uncertainty about prospective yields. The paper structures an empirical investigation of profitability and accumulation around these three factors. The Great Recession was preceded by an unbalanced recovery in which residential investment led demand while business fixed investment was structurally weak, given the strong ex post profitability of capital and the low interest rate environment. It is hypothesized that increased import penetration and concerns about the sustainability of profitability eroded both expectations and confidence about prospective yields. The Great Recession appears in this and several other dimensions to be a crisis of disproportionality.

Date: 2010
New Economics Papers: this item is included in nep-mon
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