Deutsche Bank: No, We Are Not Caught In A Liquidity Trap

booby trap

Photo: The Travel Slut

The bullish Deutsche Bank has disputed the existence of a liquidity trap in the U.S. economy, suggesting monetary policy is having a much bigger impact than people realise.A liquidity trap exists when a central bank has exhausted all monetary policy options and is unable to stimulate the economy through further policy easing. In our current environment, it would mean the Fed can’t stimulate growth through lowering interest rates or engaging in less orthodox policy choices (quantitative easing).

Deutsche Bank argue that, if we were in such a scenario, the spread between the Fed’s interest rate and GDP would be negative (emphasis ours):

One way to gauge the stance of monetary policy is to take the growth rate in nominal GDP and compare it to the level of fed funds. Today, the spread is over 400 bps—nominal GDP grew 4.4% over the past four quarters compared to a Fed funds rate of about 12 bps. This is significantly more than the 270 bps spread in Q1 2003 when nominal GDP was running 3.7% and the fund rate was 1.0%. Consequently, we would argue that industrial pricing power is stronger today than it was in 2003 and that monetary policy has more traction. Put another way, we do not believe there is a liquidity trap. For that to occur, nominal GDP would have to be below the level of interest rates.

So surely Deutsche Bank are on the side of the Bernanke supporters, keen to see quantitative easing continue, as they see monetary policy as effective.

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