Some Reflections on the Theory of the �Liquidity Trap�

Resumen

We provide a formal definition of the �liquidity trap� (LT) according to which, a LT arises if a combination of high precautionary saving, low investment and stringent conditions for access to bank credit stemming from a high degree of liquidity preference make the sum of the �neutral� interest rate and the expected inflation rate fall short of the term/risk premium on long-term interest rates. We then compare the �New Consensus� (NC) in macroeconomics as expounded in Woodford (2003) and the Post-Keynesian (PK) approach regarding the causes of a LT. We argue that in the NC approach a LT is a phenomenon caused by unusually large transitory shocks that depress the �neutral� interest rate temporarily. By contrast, we argue that in the PK approach an economy may also exhibit a �structural� or long-lasting LT even in the absence of large adverse shocks. Finally, we discuss a number of theoretical issues recently raised in the rapidly growing literature on the LT.