Liquidity Traps and the Limits of Monetary Easing during Balance-Sheet Recessions

This study examines the prevailing conditions of low inflation and liquidity trap that characterize major advanced economies. Despite the strong commitment to unconventional monetary policies and provision of ample liquidity through zerointerest rate policies and quantitative easing, there is a clear failure by central bankers to achieve the two-percent inflation targets. This paper discusses the dynamics of inflation rates and real economic growth, and considers the theoretical arguments about the liquidity trap. It focuses on the expansionary monetary policies adopted by the Bank of Japan in its extensive attempts to shape inflation expectations, and address the long-term effects of the balance-sheet recessions. Thus, it can be argued that the focus on liquidity trap and monetary easing may be misplaced, as the central issue relates to debt accumulation, leveraging, moral hazards, misalignment of incentives, and misallocation of resources rather than the dynamics of the yield curve. It is perhaps the risk-sharing relations rather than risk-transfer relations based on interest rates, that is more conducive to financial stability and more efficient allocation of risk in the society.