Why the IMF Is Wrong about Liquidity Traps

The key to economic prosperity is the generation of an abundance of real wealth. Only businesses—not government bureaucrats—are capable of achieving this.

Frank Shostak

In the Financial Times from November 2, 2020, the International Monetary Fund chief economist Gita Gopinath suggested that world economies at present are likely to be in a global liquidity trap. Gopinath has reached this conclusion because the yearly growth rate of the price indexes has been trending down despite very low interest rates policies. According to the IMF chief economist, central banks have lowered interest rates to below 1 percent and in some countries interest rates are at present negative. In the framework of a liquidity trap, it is held that the ability of central banks to stage an effective defense against various economic shocks weakens significantly. So how can one resolve the problem of the central banks” inability to produce the necessary defense of the economy?

A possible way out of the liquidity trap, suggests Gopinath, is to employ aggressive loose fiscal policy. This means aggressive government spending in order to boost the aggregate demand.

According to Gopinath,

…Fiscal authorities can actively support demand through cash transfers to support consumption and large-scale investment in medical facilities, digital infrastructure and environment protection. These expenditures create jobs, stimulate private investment and lay the foundation for a stronger and greener recovery. Governments should look for high-quality projects, while strengthening public investment management to ensure that projects are competitively selected and resources are not lost to inefficiencies.

Furthermore, according to Gopinath,

…The importance of fiscal stimulus has probably never been greater because the spending multiplier—the pay-off in economic growth from an increase in public investment—is much larger in a prolonged liquidity trap. For the many countries that find themselves at the effective lower bound of interest rates, fiscal stimulus is not just economically sound policy but also the fiscally responsible thing to do.

What exactly is the liquidity trap that the IMF chief economist is warning us about?

Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. He received his bachelor’s degree from Hebrew University, his master’s degree from Witwatersrand University, and his PhD from Rands Afrikaanse University and has taught at the University of Pretoria and the Graduate Business School at Witwatersrand University.

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Πηγή: mises.org

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