Thursday, 14 July 2011

Forget About QE3, Its All About Fiscal Policy

Here is something that I have being saying for sometime now. When interest rates get close to zero,
the economy enters a liquidity trap (see here). Nominal interest rates can not go below zero, so the main instrument of monetary policy to stimulate the economy (lowering interest rates) goes out of the window. In the IS-LM framework, the economy is stuck near zero on the y (interest rate) axis. Try the analysis for yourself.

James Galbraith takes the view that QE3 is likely to have no measurable impact on the US economy (see here). If monetary policy becomes ineffective, then that leaves fiscal policy as the only option.


  1. I enjoyed Yves Smith's opinion on Brad Delong's comments regarding the liquidity trap situation:

    IS-LM remains the workhorse for your students in intermediate macro but how many of them realize it is John Hicks's interpretation of "what Keynes meant" which is always dangerous fodder for the dogmatic orthodoxy who see no place for government in the economy.

  2. Thanks for the interesting link.