Liquidity trap and the role of monetary policy :evidence from Japan -

Abstract

The capitalist world is haunted by a threat. In order to escape from this threat, all the authorities, whether it comes from the old thinking or the new one, were allied around one objective, and that is how to escape from this threatening danger. That is the liquidity trap. Different point of views were made about this complicated concept, yet both of them, the traditional and the modern ways of thinking, agreed that an economy is found to be in a liquidity trap when the interest rates have gone very low that they have reached an irreducible floor. In this case, the country concerned is trapped in an undesired equilibrium of unemployment, and there is no deflation or any conventional monetary expansion that is capable of freeing the economy from the trap. In the beginning of the 1990s, the Japanese stagnation has started in Japan inquiries and specialists in monetary economics developed their interest in this confusing concept. In this period of time, the Bank of Japan adopted an extremely low level of interest rate and implemented an unconventional monetary policy known as Quantitative Easing”. The policies adopted by the Bank of Japan played a major role in fighting the liquidity trap and deflation. Running an econometric model which studies the relationship between the real money stock and the economic activity as well as studying the precautionary demand behavior were necessary to conclude that the Japanese economy was not stuck in a liquidity trap.