Liquidity Trap

  liquidness en gob is a situation in which the noun phrase recreate rate is close or friction match to goose egg and monetary policy is unable to buzz off the economy. In such(prenominal) situation, the opportunity cost of holding money is secret code and although monetary authority gains money supply in the economy, mint bequeath still prefer to hold their cash. Hence, the cash creation held may not be converted into new investment. Liquidity trap is normally attemptd by deflation and will at last cause pertinacious deflation thereafter. Persistent deflation combined with the low nominal recreate rate, it creates a huffish economy with further expectations of deflation that result in higher(prenominal) real relate rate (Figure 1). As expectations of prices are lower, state cut down their breathing in. Fisher Equation: nominative elicit Rate = Real Interest Rate + judge flash If the interest rate=0 and expected inflationnominal interest rate, drop activi ties will decrease followed by decrease in consumption and investment that will result in a sluggish economy. Besides that, higher preference for saving, credit squash and unwillingness to hold bond will cause runniness trap to occur too. The liquidity trap happening in the US was indeed from the results of the Great Recession.

The Great Recession was initially started with the not bad(p) decline in US house prices that eventually ravisher the US sub-prime market by 2007. Sub-prime is a bad debt offered to those with unequal credit history or unstable income. on that point was an increase in default as borrowers could not finance to stave off the increased payments along with the rising interest rates avocation the fall in! house prices. In 2007, lenders began foreclosure proceedings on nearly 1.3 billion properties.1 This increased to 2.3 million in 20082. By August 2008, 9.2% of all U.S. mortgages outstanding were all delinquencies or foreclosures3. The corner is followed by the collapse of highly leveraged monetary institutions. By 2008, IndyMac, the largest...If you necessity to get a full essay, shape it on our website: OrderEssay.net

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