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A Note on Krugman’s Liquidity Trap and Monetary Policy at the Zero Lower Bound

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  • Stefano Di Bucchianico
Abstract
Krugman's ‘liquidity trap’ model constituted a ground-breaking contribution by attributing the long-lasting Japanese stagnation to a negative natural interest rate. Our critique to such a proposal will focus on three aspects. First, we will question the logical structure of the model, providing an alternative interpretation of its closure and arguing that aggregate demand has no crucial role in it. Second, we will argue that a negative natural interest rate can emerge only after a series of overtly restrictive assumptions in a model that does not treat capital and avoids long-run equilibrium analysis. Finally, we will discuss the mainstream literature which followed up until the recent rediscovery of the Secular Stagnation Theory. Within that line of literature, the key features of the ‘liquidity trap’ model continue to occupy a prominent role, thereby letting the critical issues that have been singled out resurface. Our conclusion is that the ‘liquidity trap’ explanation did not provide a satisfying rationale for Japan’s stagnation and cannot describe later economic predicaments either. A comparison with Post-Keynesian models shows their ability to offer insightful policy prescriptions without relying on those shaky theoretical foundations.

Suggested Citation

  • Stefano Di Bucchianico, 2020. "A Note on Krugman’s Liquidity Trap and Monetary Policy at the Zero Lower Bound," Review of Political Economy, Taylor & Francis Journals, vol. 32(1), pages 99-120, July.
    • Handle: RePEc:taf:revpoe:v:32:y:2020:i:1:p:99-120
    DOI: 10.1080/09538259.2020.1731119
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    Cited by:

    1. Ciaffi, Giovanna & Deleidi, Matteo & Di Bucchianico, Stefano, 2024. "Stagnation despite ongoing innovation: Is R&D expenditure composition a missing link? An empirical analysis for the US (1948–2019)," Technological Forecasting and Social Change, Elsevier, vol. 206(C).
    2. Stefano Di Bucchianico, 2021. "Negative Interest Rate Policy to Fight Secular Stagnation: Unfeasible, Ineffective, Irrelevant, or Inadequate?," Review of Political Economy, Taylor & Francis Journals, vol. 33(4), pages 687-710, October.
    3. Sergio Cesaratto & Stefano di Bucchianico, 2020. "Endogenous money and the theory of long-period effective demand," Bulletin of Political Economy, Bulletin of Political Economy, vol. 14(1), pages 1-38, June.
    4. Di Bucchianico, Stefano, 2020. "Discussing Secular Stagnation: A case for freeing good ideas from theoretical constraints?," Structural Change and Economic Dynamics, Elsevier, vol. 55(C), pages 288-297.
    5. Di Bucchianico, Stefano, 2021. "Inequality, household debt, ageing and bubbles: A model of demand-side Secular Stagnation," IPE Working Papers 160/2021, Berlin School of Economics and Law, Institute for International Political Economy (IPE).

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