Entrepreneurship, knowledge and employment

Robertson's "Liquidity Trap" as an answer to Keynes's "Banana Parable"

Barens Ingo, Darmstadt University of Technology

Contrary to a widely held belief John M. Keynes did not invent the term "liquidity trap". It was coined by Dennis H. Robertson in the course of a critical re-examination of the "banana parable" of Keynes' Treatise on Money". Contrary to the present understanding of a "liquidity trap" - additional liquidity supplied by the central bank is "trapped" and thus kept from lowering the rate of interest - Robertson used the term "liquidity trap" because he saw liquidity as such, or more precisely liquidity preference, as a "death-trap" for additional savings, preventing a fall in the rate of interest sufficient to fully compensate the leakage of consumption demand by an increase of investment demand. On the one hand, Robertson's "liquidity trap" does not refer to a lower bound of the rate of interest but is operative at any level of interest. On the other hand, and consequently, his "liquidity trap" is not concerned with monetary policy becoming impotent at some (zero or positive) lower bound of the rate of interest. Instead he is concerned with th inattention of the central bank in the face of increasing demand for liquidity by the public. As Robertson, in developing his idea of a "liquidity trap", focussed on one particular part of the "banana parable" that seemed to imply a malfunction of the interest mechanism, his notion of "liquidity trap" can be interpreted as a rejection of Kenes's argument as to the necessity of the downward spiral of output and employment caused by an excess of savings over investment. His notion of "liquidity trap" did not refer to the impotence of monetary policy; instead it argued that a central bank could defang the "liquidity trap" and thus avoid any downward spiral by doing its job - supplying additional liquidity if the public so desired.

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Keywords: Keynes, banana parable, General theory, liquidity trap, Robertson, loanable funds

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