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To: Bobby Yellin who wrote (12466)	6/1/1998 2:46:00 PM
From: Abner Hosmer	Respond to of 116900

Hi Bobby, Don't know if this has been posted yet, got it from the Asia thread. Krugman on Japan, liquidity trap: web.mit.edu >>The purpose of this paper is to show that the liquidity trap is a real issue - that in a model that dots its microeconomic i's and crosses its intertemporal t's something that is very much like the Hicksian liquidity trap can indeed arise. Moreover, the conditions under which that trap emerges correspond, in at least a rough way, to some features of the real Japanese economy. To preview the conclusions briefly: in a country with poor long-run growth prospects - for example, because of unfavorable demographic trends - the short-term real interest rate that would be needed to match saving and investment may well be negative; since nominal interest rates cannot be negative, the country therefore "needs" expected inflation. If prices were perfectly flexible, the economy would get the inflation it needs, regardless of monetary policy - if necessary by deflating now so that prices can rise in the future. But if current prices are not downwardly flexible, and the public expects price stability in the long run, the economy cannot get the expected inflation it needs; and in that situation the economy finds itself in a slump against which short-run monetary expansion, no matter how large, is ineffective.. ...The fourth part then argues that making the analysis a bit less stylized - introducing investment and international trade - does not alter the basic conclusions: neither investment nor even the possibility of exporting excess savings to other countries necessarily eliminate the possibility of a liquidity trap.<<