Journal Club Discussion 3/30 – Expansionary Policy in a Liquidity Trap: Lessons from Japan’s Lost Decade(s)

Date: Monday, March 30, 2015

Location: Huntsman (JMHH) G50

Time: 7:00 PM

After 40 years of impressive growth, the early 1990s saw Japan, then the world’s second largest economy, stumbling into a period of economic stagnation with no real recovery in sight. Even with the Bank of Japan’s aggressive monetary response, the deflationary trend appeared to be unstoppable. Many argue that the abnormalities of Japan’s economic system – weak financial regulations, crony capitalism, and conspicuous consumption – fueled a speculative asset bubble that eventually burst and brought the economy down with it. These claims, however, cannot be verified without a suitable framework for understanding Japan’s condition.

On the theoretical side, some economists point to Japan’s slump as a classic example of a liquidity. This proposition, however, remains as widely disputed as the policy implications that follow. During our discussion, we will briefly examine the concept of a liquidity trap as described through the new Keynesian model and then seek to evaluate the viability of its policy recommendations. The primary reading, Japan’s Trap by Paul Krugman (1998), provides a digestible overview of the topic in light of Japan’s economic stagnation. The secondary reading, The New-Keynesian Liquidity Trap by John Cochrane (2015), presents an elaborate critique of the policy predictions of the new Keynesian model. We will also look at historical data to inform our conversation on the relevance of both arguments. Can policy makers act to save an economy in a liquidity trap? If so, what can be done? We hope that the conversation will allow us to better evaluate policy responses in deflationary circumstances.

Readings

  1. Krugman (1998), “Japan’s Trap”.
  2. Cochrane (2015), “The New-Keynesian Liquidity Trap”.
  3. Krugman (2013), “Monetary Policy in a Liquidity Trap”, The New York Times.

P.S. While the discussion will cover theoretical material, participants are not expected to be well versed in the mathematical expositions of the subject. The readings are merely meant to provide relevant background information to help stimulate further discussion.

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