Reading Keynes at the Zero Lower Bound: The Great Depression, the Liquidity Trap, and Unconventional Policy

Abstract

John Maynard Keynes’s analysis of the Great Depression has strong parallels to recent theorizing about the post-2008 Great Recession. There are also remarkable similarities between the two historical episodes: the collapse of demand for new fixed investment, the role of the zero lower bound liquidity trap in hampering conventional monetary policy, the multi-year period of near-zero short-term rates, and the protracted period of subnormal prosperity. A major difference between then and now is that monetary authorities in the recent situation actively pursued an unconventional policy with massive purchases of long-term securities. Keynes couldn’t convince authorities of his era to pursue such a plan, but it was precisely the monetary policy he advocated for a depressed economy stuck at the zero lower bound of nominal interest rates.

Los límites de la política monetaria: de la trampa de la liquidez al zero lower bound

“…No obstante, después del estallido de la crisis en 2008 y a raíz de los problemas que enfrentaron los principales bancos centrales del mundo, la idea de la trampa de liquidez se recuperó. En estos análisis la discusión se realiza en torno a la interpretación que se hace de la teoría de Keynes con el fin de explicar el límite encontrado en la implementación de la política monetaria (Kregel, 2014;Bullio Mattos et al, 2019;Palley, 2019) o de justificar la utilización de las políticas monetarias no convencionales desde una perspectiva keynesiana (Sutch, 2018).…”

Untitled

“…Conventional policy may reduce the short-term interest rate to its lower bound of zero or just below without materially shifting the long-term rate. For this reason, Keynes favoured direct intervention to reduce the long-term interest rate through the purchase of long-term government bonds (Sutch 2018). In the wake of the financial crisis, central banks followed the advice of Keynes, although their purchases covered a wider range of assets than he envisaged and included private-sector assets with a relatively long duration and/or a relatively high credit risk.…”