Reply #56: How close are we to a liquidity trap? Paul Krugman

[Demeter]

http://krugman.blogs.nytimes.com/2008/03/17/how-close-are-we-to-a-liquidity-trap/


Here’s one way to think about the liquidity trap — a situation in which conventional monetary policy loses all traction. When short-term interest rates are close to zero, open-market operations in which the central bank prints money and buys government debt don’t do anything, because you’re just swapping one more or less zero-interest rate asset for another. Alternatively, you can say that there’s no incentive to lend out any increase in the monetary base, because the interest rate you get isn’t enough to make it worth bothering.

Normally it doesn’t matter which short-term interest rate you choose — the Fed funds rate, which Uncle Ben sets, is usually very close to the interest rates on US government debt. But right now we’re in a situation in which Treasury bills yield considerably less than the Fed funds rate; to at least some extent this may reflect banks’ nervousness about lending to each other, even in the overnight market. And to the extent that’s true, Treasuries — not Fed funds — are the interest rates to look at.

As of 10:38 this morning, the one-month Treasury rate was 0.57; the three-month rate was 0.825.
Are we there yet? Pretty close.