Money, Banks and Finance in Economic Thought

At the origin of the concept of "liquidity trap": early discussions between Robertson and Keynes

Fantacci Luca, Bocconi University, Milan
Sanfilippo Eleonora Sanfilippo, University of Cassino and Southern Lazio

The concept of “liquidity trap" has recently experienced a revival in macroeconomics. It was first resumed at the end of the 1990s as a theoretical tool useful to interpret the long-lasting stagnation of the Japanese economy (Krugman 1998). Subsequently, particularly after the outbreak of the Global financial crisis, it was considered as an analytical device apt to explain the economic crisis itself, the persistence of low levels of economic activity after the crisis and the failure of ‘conventional’ monetary policy to boost the economy, experienced in most countries during the last years (e.g. Blanchard 2017; Blanchard et al. 2010). The definition of “liquidity trap”, however, is not univocal; indeed, there are differing views concerning the analytical conditions that should characterize it (Barens 2011, Krugman 2010). In most textbooks and macroeconomic models, the liquidity trap is identified with the zero lower bound on interest rates. Other contributions have stressed, instead, that the ineffectiveness of monetary policy may arise even at positive levels of the rate of interest (e.g. Fellner 1992). Quite recently, even the possibility of the liquidity trap to occur has been put into question from a Neoclassical perspective (Ahiakpor 2018).The impression is that, despite its wide use in macroeconomics textbooks and modeling, there is ambiguity on what the “liquidity trap” really is and on the theoretical reasons of its occurrence. It may be useful, therefore, to turn back to the original meaning of this concept in the works of the economists that first introduced and discussed it in economic analysis, i.e. Keynes and Robertson. In fact, the possibility that, under certain circumstances, expansionary monetary policy might prove ineffective in lowering the rate of interest was first envisaged by Keynes in the General Theory (1936), while the expression “liquidity trap” was first used by Robertson in his Essays in monetary theory (1940) to describe the role of hoarding in perpetuating economic depression. Very few studies (see Boianovsky 2004, Barens 2011, 2018) have been devoted to the reconstruction, from a history of economic thought perspective, of the debate from which the concept of “liquidity trap” emerged, and relevant archival documents remain to be explored from the correspondence between Robertson and Keynes. Building on previous investigations and unpublished material, the aim of this paper is, therefore, to provide a contribution to clarify the meaning of the concept of “liquidity trap”. In particular, it highlights that in the early theoretical debates among the first economists who confronted with this issue, this phenomenon not only was not considered necessarily associated to the zero lower bound and analytically derived from the latter, but was related with broader questions concerning the true nature of liquidity and the related structural tendency of a monetary economy towards stagnation.

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Keywords: Keynes, Robertson, Liquidity Trap, Ineffectiveness of Monetary Policy

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