Why the world is about to enter into a Liquidity Trap?

In the last few days we have been informed by the statistic offices that Japan’s economy has plunged again into deflation. Mainly for the same reasons, the Euro zone is also experimenting another drop in the negative territory of the core inflation index. It seems like the World is about to enter into the Liquidity Trap.

The risks are high if they materialize. A liquidity trap is what the central banks want less. It’s defined like a situation in which the central banks can’t control inflation. If the further raise of the money supply by the central banks through the QE can’t bounce back inflation, what can do it?

Once the downward spiral in the prices is opened it’s hard to halt it. The perfect storm will be inevitable if the commodity prices continue to remain at these levels. Inflation is slumping everywhere around the world, even in Russia. A bad sign came yesterday from the Reserve Bank of India. The central bank of one of the major economy of the world, cut interest rates as even there, inflation is not more a problem.

The world’s economy has been quite reliant on the QE of the major central banks in the last years. Actually, this monetary stimulus program is not having any strong impact in the core inflation as extremely low commodity prices continue to pressure it on the downside. Also the global demand remains under potential because of the sluggish growth in the developing countries. Mainly for internal reasons the Chinese economy is slowing down the pace, this also applies to the Brazil economy.

A strong debate in the academic world is going on about if the low productivity is one of the reasons of this slow growth in many developed economies. At the same time there is a strong debate about why the productivity is so low respect to the previous years.

Probably the lower productivity is one of the main reasons but it’s not the only one. At this point the central banks won’t hesitate to adjust the monetary policy with even higher QE. Could it be sufficient to adjust the problems? Some of the major players of the markets are skeptic. These investors sustain that the central banks have finished their job. Now is the turn of the governments. To boost the global growth, more than currency wars, we need lower taxes, lower public debts and more investments by the private sector.

The governments in a coordinated action, through private and public infrastructure funds and venture funds, can boost the global economic growth. To prevent in time the slump in the global growth, we need further actions, more by the central governments than by the central banks.

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1 Response

  1. robert says:

    We have been in a liquidity trap, along with Japan for a long time…

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