Battling a Liquidity Trap
Discovering More Tools in the Fed's Tool Chest
CHICAGO, October 12, 2011 – In the October issue of Themes on the Economy®, Chief Economist Diane Swonk takes a look at whether the U.S. has fallen into a liquidity trap, much as Japan did during the 1990s. Historically, the only way to combat a liquidity trap was to expand government spending, to compensate for reluctant private investment. Given new research and the reality that Washington is not in a spending mood, Swonk explains what tools the Federal Reserve could use now. Read this month's issue.
- What is a liquidity trap? Banks are awash in capital, large companies in cash, but they are reluctant to open the floodgates and let this unprecedented liquidity flow into the economy.
- To illustrate the dilemma, Swonk quotes the Romantic poet, Samuel Taylor Coleridge: "Water, water, everywhere, Nor any drop to drink," adding that, "I remember picturing a sailor dying of thirst," adrift on a sea of undrinkable salt water.
- But the Federal Reserve is not helpless. "Central banks can and have shown an ability to affect output growth by shifting expectations, once the zero bound (on interest rates) is hit," Swonk said. "Naysayers worry that any such shifts in the expectations component of monetary policy, although sound in theory, could backfire in practice," or even "seed future bubbles," Swonk noted.
- "It looks like the Fed is heading toward an unemployment target, before it goes all out on reflating the economy with a temporarily higher inflation target," she predicted.
- Swonk argues that, "the key for policy makers is to provide some level of certainty," so that companies feel more comfortable investing.
The October issue of Themes on the Economy® as well as archived issues can be found at mesirowfinancial.com.
Mesirow Financial is a diversified financial services firm headquartered in Chicago. Founded in 1937, it is an independent, employee-owned firm with approximately 1,200 employees globally. With expertise in Investment Management, Global Markets, Insurance Services and Consulting, Mesirow Financial strives to meet the financial needs of institutions, public sector entities, corporations and individuals. For more information about Mesirow Financial, visit its website at mesirowfinancial.com.
The Mesirow Financial name and logo are registered service marks of Mesirow Financial Holdings, Inc., © 2011, Mesirow Financial Holdings, Inc. All rights reserved. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed are subject to change without notice. It should not be assumed that any recommendations incorporated herein will be profitable or will equal past performance. Nothing contained herein constitutes an offer to sell or a solicitation of an offer to buy an interest in any Mesirow Financial investment vehicle(s).
Securities offered through Mesirow Financial, Inc. member NYSE, SIPC. Insurance services provided through Mesirow Insurance Services, Inc.
