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Liquidity Traps, Local and Global (Somewhat Wonkish)

Paul Krugman Krugman Blog
Date Posted:
April 2, 2015
Is Database:
Database

Europe’s liquidity trap is driven by weak domestic demand, low inflation, and a shared currency without fiscal integration.

The debate on liquidity traps highlights the persistent challenges of secular stagnation, particularly in Europe, where declining working-age populations and a shared currency without fiscal integration contribute to a contractionary fiscal policy bias. Core inflation in Europe is at 0.6%, indicating weak domestic demand, which is exported globally through large current account surpluses. This situation is exacerbated by low inflation interacting with the zero lower bound, preventing interest rates from reaching their equilibrium. Despite international capital mobility, liquidity traps can persist locally if domestic demand remains weak, as seen in Japan's experience with deflation and the zero lower bound. The global savings glut, driven by countries like Germany, suggests that these imbalances will continue unless policies are implemented to boost demand and address trade and capital flow imbalances.

really good Krugman on the Bernanke/Summers debate "...Bernanke correctly, I’d argue, criticizes Summers for insufficient attention to international capital flows - but then argues that once you do allow for international capital movement it obviates many of the secular stagnation concerns, which I believe is wrong....most persuasive evidence that the US may face secular stagnation comes from the lackluster recovery of 2001-2007...mother of all housing bubbles...unsustainable rise in household debt... a fairly unimpressive expansion by historical standards....seem to point to fundamental weakness in private demand. But one reason for the sluggish growth in demand for U.S.-produced goods and services was a huge trade deficit, the counterpart of huge reserve accumulation in China and other emerging markets. So Bernanke argues that what Summers sees as evidence of secular stagnation actually reflects the global savings glut....moral of the Japanese example is that if other countries are managing to achieve a moderately positive rate of inflation, but you have let yourself slip into deflation or even into “lowflation”, you can indeed manage to find yourself in secular stagnation even if the rest of the world offers positive-return investment opportunities. Which brings me to the future of the global savings glut....the case for secular stagnation in Europe is considerably stronger than it is for the U.S.. Working-age population is declining, Japan-style; the euro system, with a shared currency but no fiscal integration, arguably imparts a strong contractionary bias to fiscal policy; and core inflation is already down to just 0.6 percent.By the logic I’ve already laid out, this should imply a persistently very weak euro and a persistently large European current account surplus, as Europe in effect tries to export its secular stagnation - a process limited only by the way low inflation or deflation interact with the zero lower bound to keep interest rates from falling to their Wicksellian equilibrium rate....implies is that even if you downplay domestic U.S. weakness and focus on the export of capital from other countries, especially Germany, there’s no good reason to believe that this new version of the global savings glut will end any time soon.....Europe’s trade and capital imbalances are the result of fundamental weakness of domestic demand, which is then exported to the rest of us, who aren’t that strong either. If true, this says that we have a problem that must be solved with policies that boost demand. So on the policy debate, I come down firmly on the Summers side...." Krugman, Paul, "Liquidity Traps, Local and Global (Somewhat Wonkish),"Krugman Blog, April 1, 2015. Available at:http://krugman.blogs.nytimes.com/2015/04/01/liquidity-traps-local-and-global-somewhat-wonkish/Liquidity Traps, Local and Global (Somewhat Wonkish) April 1, 2015 Photo

Liquidity Traps, Local and Global (Somewhat Wonkish): Extended Excerpt Image 1

Credit International Monetary Fund

If my analysis of the European problem is right, however, this is pretty much irrelevant: Europe’s trade and capital imbalances are the result of fundamental weakness of domestic demand, which is then exported to the rest of us, who aren’t that strong either. If true, this says that we have a problem that must be solved with policies that boost demand. So on the policy debate, I come down firmly on the Summers side. Mobile908.303.9747Office212.404.4646

he US and the international community should continue to oppose national policies that promote large, persistent current account surpluses and to work toward an international system that delivers better balance in trade and capital flows.

Which brings me to the policy debate. Bernanke seems to be saying that if there is a problem, it can be solved by cracking down on currency manipulation:

What this in turn implies is that even if you downplay domestic U.S. weakness and focus on the export of capital from other countries, especially Germany, there’s no good reason to believe that this new version of the global savings glut will end any time soon.

Sure enough, if we try to figure out the market’s implied prediction for the euro, it seems to imply persistent weakness. The euro/dollar rate is down around 30 percent from its level before Europe began running such large surpluses. Meanwhile, German 10-yearreal interest ratesare around -1, while U.S. real rates are slightly positive; this implies that markets expect the euro to recover only a third or so of its recent decline over the next decade.

By the logic I’ve already laid out, this should imply a persistently very weak euro and a persistently large European current account surplus, as Europe in effect tries to export its secular stagnation - a process limited only by the way low inflation or deflation interact with the zero lower bound to keep interest rates from falling to their Wicksellian equilibrium rate.

And this makes sense: the case for secular stagnation in Europe is considerably stronger than it is for the U.S.. Working-age population is declining, Japan-style; the euro system, with a shared currency but no fiscal integration, arguably imparts a strong contractionary bias to fiscal policy; and core inflation is already down to just 0.6 percent.

But look at what bond markets are saying! German interest rates - presumably an indicator of perceived euro safe rates - are negative out to seven years; the 10-year rate is only 16 basis points. This is telling us that markets expect the euro area economy to be depressed, and ECB rates very low, for many years to come. In effect, European bond markets are flashing a secular stagnation warning.

As Bernanke notes, as far as big current account surpluses go, Germany is the new China. However, he argues that the large current account surplus of the euro area as a whole is a temporary phenomenon driven by cyclical weakness in the euro periphery, and therefore not likely to be a source of persistent trouble.

Which brings me to the future of the global savings glut.

The moral of the Japanese example is that if other countries are managing to achieve a moderately positive rate of inflation, but you have let yourself slip into deflation or even into “lowflation”, you can indeed manage to find yourself in secular stagnation even if the rest of the world offers positive-return investment opportunities.

OK, it’s not full equalization. but not too far off — despite being at the zero lower bound for many years, Japan ended up offering more or less competitive real returns.

The answer is that real returns in Japan weren’t exceptionally low - they were, in fact, more or less equal to those abroad. But this equalization of real rates didn’t occur through an equalization of Wicksellian natural rates. Instead, what happened was that persistent deflation in Japan, combined with the zero lower bound, kept the actual real interest rate well above the Wicksellian rate. Here’s the data from 1996 to 2008, with inflation measured by the GDP deflator and interest rates measured by 6-month Libor:

When I first approached this issue, that’s what I thought. But I immediately ran up against a big real-world counterexample: Japan. Japan has effectively been at the zero lower bound since the 1990s, and it wasn’t until the end of 2008 that the rest of the advanced world joined it there. So why didn’t capital flood out of Japan in search of higher returns, driving the yen down and boosting Japan out of its trap?

Still, secular stagnation - as opposed to liquidity-trap analysis in general - is concerned with excess saving that lasts a very long time, that’s quasi-permanent. So in that case wouldn’t we expect capital mobility to be decisive? Shouldn’t it be impossible to have secular stagnation in just one country?

But this isn’t right if the weakness in European demand is perceived as temporary (where that could mean a number of years). For in that case the weakness of the euro will also be seen as temporary: the further it falls, the faster investors will expect it to rise back to a “normal” level in the future. And this expected appreciation back toward normality will equalize expected returns after a decline in the euro that is well short of being enough to raise the natural rate of interest all the way to its level abroad. International capital mobility makes a liquidity trap in just one country less likely, but it by no means rules that possibility out.

You might think not: as long as there are positive-return investments abroad, capital will flow out. This will drive down the value of the euro, increasing net exports, and raising the Wicksellian natural rate. So you might think that you can’t have a liquidity trap in just one country, as long as capital is mobile.

Let’s first ask whether the possibility of investing abroad obviates the problem of liquidity traps in general (as opposed to secular stagnation.) To do this, consider theanalysis I laid outa couple of months ago when I was trying to think about the dollar and U.S. recovery, but run it in reverse. Suppose that a country or currency area - let’s call it Europe — suffers a decline in aggregate demand. And suppose that this threatens to push the Wicksellian natural rate of interest - the rate of interest at which desired savings and investment would be equal at full employment — below zero. Can this happen if there are positive-return investments outside of Europe?

That’s a good point. But Bernanke then goes on, as I understand him, to argue that international capital flows should solve the problem of secular stagnation unless if affects the world as a whole, because capital can seek higher returns abroad; he also argues that the global savings glut is mainly a thing of the past, and that in any case such problems can be addressed mainly by putting pressure on foreign governments to open their capital accounts and stop pursuing policies that promote excessive current account surpluses. And in these assertions, I’d suggest, he goes somewhat astray.

Start with Bernanke’s critique of Summers. The most persuasive evidence that the US may face secular stagnation comes from the lackluster recovery of 2001-2007. We experienced the mother of all housing bubbles, fueled by a huge, unsustainable rise in household debt - yet all we got was a fairly unimpressive expansion by historical standards, and little if any inflationary overheating. This would seem to point to fundamental weakness in private demand. But one reason for the sluggish growth in demand for U.S.-produced goods and services was a huge trade deficit, the counterpart of huge reserve accumulation in China and other emerging markets. So Bernanke argues that what Summers sees as evidence of secular stagnation actually reflects the global savings glut.

As it happens, the role of capital flows in the logic of liquidity traps is an issue I tackled right at the beginning, back in 1998; and I’ve been trying to work out how it plays into the discussion of secular stagnation, which is basically the claim that countries can face very persistent, quasi-permanent liquidity traps. So I think I may have something useful to add here.

There’s been a really interesting back and forth betweenBen BernankeandLarry Summersover secular stagnation. I agree with most of what both have to say. But there’s a substantive difference in views, in which Bernanke correctly, I’d argue, criticizes Summers for insufficient attention to international capital flows - but then argues that once you do allow for international capital movement it obviates many of the secular stagnation concerns, which I believe is wrong.

  • Inflation
  • GDP
    • Business Cycle
    • Growth
    • Savings Glut/Trade Deficit
Previous articleApril 1, 2015On Secular Stagnation: A Response to Bernanke@LHSummers: The concept of secular stagnation is explored as a significant factor in recent macroeconomic developments, with excess foreign saving depressing real interest rates & global coordination necessary to ensure adequate demand & distribution.Next articleApril 7, 2015Do You Really Want to Know How Ben Bernanke Thinks? Also andBen Bernanke’s economic perspective focuses on the natural rate of interest, where supply and demand for safe assets are balanced at full employment. @LHSummers and @PaulKrugman debate global imbalances and secular stagnation.
Showing 111 database articles primarily about Inflation

Choking Iran's Economy Is the Least Bad Way to End the War

AI Summary. Iran's economy is contracting at its fastest rate in roughly 40 years, with inflation above 50%, food costs doubling year-over-year, and the national currency near worthless.

Javier Blas Bloomberg
Date Posted:
August 20, 2026
Is Database:
Database

Inflation in Iran is running at at least ~69%, its highest annual rate in 70 years. The black market exchange value of a rial hit a record low of ~1.85mm rials to the dollar, relative to 50,000 per dollar five years ago.

Is economic collapse the only path to ending the conflict?

Core argument: Iran’s inflation rate exceeds 50% annually — the highest in nearly 70 years of records — while food and essential goods costs have doubled year over year, severely compressing household purchasing power across the economy.

[Iran's] economy is on track to suffer the biggest annual contraction since the nadir of the Iran-Iraq War in the mid-1980s. Inflation is running well above 50%, the highest annual rate since records start nearly 70 years ago. Worse, the cost of food and other necessities has already doubled from a year ago. Its currency, the rial, is worthless. In the black market, the exchange rate has collapsed to a record low of about 1.85 million rials to the dollar; five years ago, roughly 50,000 rials were enough to buy a greenback.

Takeaways by Macro Roundup® AI

  1. Iran’s inflation rate exceeds 50% annually — the highest in nearly 70 years of records — while food and essential goods costs have doubled year over year, severely compressing household purchasing power across the economy.
  2. Iran’s GDP is on track for its steepest annual contraction since the mid-1980s Iran-Iraq War nadir, a deterioration that surpasses every recessionary episode across four intervening decades.

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  • For the Oil Market, the Strait of Hormuz Isn’t Closed — At least 5m barrels of oil per day continue to transit the Strait of Hormuz, with the true volume likely higher as growing oil spills from tanker attacks indicate ongoing vessel traffic despite efforts to close the waterway.
  • U.S. Economy Less Vulnerable To Geopolitical Oil Price Shocks Than In The Past — Kilian, et al find that the impact of an energy shock on US real GDP growth has fallen to 1/20th of what it would have been in 1980, due both to the declining…
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A Return To Monetarism?

AI Summary. Excessive money growth reliably signals inflationary pressure regardless of whether its source is monetary or fiscal policy, because any fiscal expansion that increases money supply is captured in price-gap models tracking monetary aggregates.

Peter Ireland, Stephen Miran and Nouriel Roubini Hudson Bay Capital
Date Posted:
July 16, 2026
Is Database:
Database
Is Important:
Important

Ireland, Miran, and Roubini compare the actual price level to the predictions of an equilibrium model relating prices to money supply. Predicted inflation hit a 60-year high in 2020–21, months before inflation surged and then crashed once the Fed hiked.

Does excess money growth always predict inflation regardless of its source?

The graphs in Figure 3 show quite clearly how the surge in money growth starting in 2020 and continuing in 2021 put enormous upward pressure on inflation, to a degree unprecedented in the post-1967 sample period. And while the large and negative price gaps that followed in 2022 and 2023 are likewise indicative of strong disinflationary pressures applied through subsequent monetary tightening, one can’t see these graphs without asking: Had Federal Open Market Committee members been monitoring measures of money growth with the help of the P-star [price target based on monetary aggregates] model, might they have ended QE and raised interest rates sooner and more quickly, thereby avoiding at least some of the post-2020 inflation? Of course, massive fiscal expansion was another driver of the post-2020 surge in inflation, as suggested by fiscal theories of the price level. The model simply observes that regardless of its originating source, excessive money growth signals that inappropriate macroeconomic policies are fueling higher inflation. Fiscal expansions that expand money supply will be reflected in a P-star model.

Related Articles:

  • Money and Inflation — Jesper Rangvid argues that monetarist theory would have predicted deflation from the recent contraction in the M2 money supply. Continuing inflation leaves him…
  • State Dependence of Monetary Policy During Global Supply Chain Disruptions — Bai, et al present evidence that btw 2017 and 2023, monetary tightening reduced US inflation relatively more than output during periods of global supply chain…
  • What Next for r*? A Capital Market Equilibrium Perspective On The Natural Rate of Interest — In a base model, steady state r* is still ~0, suggesting that “secular stagnation” may not be a thing of the past. AI expansion and inflation risk could each…
  • Inflation
  • GDP
  • Monetary Policy

Home Alone: Inflation And The New Fed Chair

AI Summary. Current inflation conditions — including labor market tightness, price pressures, supply chain stress, and the output gap — align more closely with historical conditions that prompted the Federal Reserve to raise rates than to cut them. Averaging multiple monetary policy benchmarks points to an optimal interest rate range of 4.00%–4.85%

Michael Cembalest J.P. Morgan
Date Posted:
May 27, 2026
Is Database:
Database

Cembalest notes labor market tightness, price pressures in the manufacturing sector and the implied output gap are “much closer to conditions that have historically prompted the Fed to raise policy rates rather than to lower them.”

Does current inflation warrant higher rates than the Fed currently plans?

Core argument: Monetary policy rules average a 4.00–4.85% Fed Funds range vs. the current 3.50–3.75%, indicating tightening bias drives futures pricing toward.

Inflation indicators the Fed watches include labor market tightness, price pressures in the manufacturing sector, supply chain tightness and the “output gap” which measures how far actual growth is above/below potential growth. [The two] charts plot these four variables at the time of prior Fed decisions to increase or cut policy rates; green dots indicate when the Fed cut, red dots indicate when the Fed tightened and yellow circles show today’s values. In other words: current values are much closer to conditions that have historically prompted the Fed to raise policy rates rather than to lower them. That may be why the futures curve is now pricing in Fed hikes instead of the cuts that were priced in at the start of the year. Superwonky: averaging several different monetary rules of thumb (Taylor rules, inertial, alternative r*, forward-looking) yields a Fed Funds range of 4.00% - 4.85% compared to the current range of 3.50% - 3.75%.

Takeaways by Macro Roundup® AI

  1. Monetary policy rules average a 4.00–4.85% Fed Funds range vs. the current 3.50–3.75%, indicating tightening bias drives futures pricing toward.
  2. Labor market tightness, manufacturing price pressures, supply chain constraints, and positive output gaps align with historical rate-increase conditions, leading markets.

Related Articles:

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  • The Dangerous Brew That’s Rattling Bond Markets — Government borrowing across major economies has reached unprecedented peacetime levels, with U.S. deficits averaging 6.2% of GDP from 2023–2026 versus 4.1% in the early 2000s. Since 2020, economic shocks have consistently pushed inflation higher rather than lower, forcing long-term interest rates up and adding an estimated $
  • Are Government Bonds Safe in Times of War and Pandemic? — US government bonds, normally safe assets, become risky in times of war because of negative real returns due to bursts of inflation. As in the fiscal theory of…
  • Inflation
  • GDP
  • Monetary Policy

US Consumer Sentiment Slides to Record Low on Price Concerns

AI Summary. US consumer sentiment has fallen to a record low, driven by rising price expectations of 4.8% over the next year and 3.9% over the long term.

María Paula Mijares Torres Bloomberg
Date Posted:
May 26, 2026
Is Database:
Database

The Michigan Consumer Sentiment Index hit a record low in May, falling ~10% month over month. Consumers foresee prices advancing 4.8% over the next year. Inflation and high gas prices have long been major causes of sentiment drops.

Are rising price expectations undermining consumer confidence?

Core argument: Michigan consumer sentiment fell 5 pts to 44.8, undershooting all economist forecasts, driving heightened recession risk perceptions.

The University of Michigan’s final May sentiment index decreased 5 points to 44.8 from April. The gauge was weaker than all projections in a Bloomberg survey of economists as well as the preliminary reading of 48.2. Consumers expect prices to rise an annualized 3.9% over the next five to 10 years, up from 3.5% in April and the highest in seven months. They also saw costs advancing 4.8% over the next year.

Takeaways by Macro Roundup® AI

  1. Michigan consumer sentiment fell 5 pts to 44.8, undershooting all economist forecasts, driving heightened recession risk perceptions.
  2. Five-to-10-year inflation expectations surged to 3.9% from 3.5% month-over-month, the highest in seven months, leading to eroded purchasing power confidence.
  3. One-year price expectations of 4.8% vs. 3.9% long-term forecasts signal consumers expect near-term cost acceleration to outpace eventual moderation.

Related Articles:

  • The Cost of Money is Part of the Cost of Living: New Evidence on the Consumer Sentiment Anomaly — US consumer sentiment is significantly lower than expected based on unemployment and inflation. Alternative measures of inflation that include borrowing costs…
  • The Dangerous Brew That’s Rattling Bond Markets — Government borrowing across major economies has reached unprecedented peacetime levels, with U.S. deficits averaging 6.2% of GDP from 2023–2026 versus 4.1% in the early 2000s. Since 2020, economic shocks have consistently pushed inflation higher rather than lower, forcing long-term interest rates up and adding an estimated $
  • $50 Trillion Safe-Haven Debt Market Upended by Iran War Inflation — The $50tn market for Group of Seven sovereign bonds is under pressure as investors price in persistent inflation, driving long-term yields to their highest level in two decades. Rising government debt and unresolved post-pandemic price pressures are compounding the risk, forcing expectations of higher interest rates to contain inflation.
  • Inflation
  • GDP
  • Politics

Where Did All the Affordable Cars Go?

AI Summary. The average new car costs ~$50,000, with sub-$20,000 options nearly extinct, while repair costs have risen 15%, making car ownership unaffordable for budget consumers. Removing import barriers on lower-cost foreign vehicles would expand access, as comparable Chinese models sell for ~$20,000 less than U.S. equivalents while offering superior performance

Clifford Winston New York Times
Date Posted:
April 15, 2026
Is Database:
Database

In 2012, there were ~12 new cars available for around $25,000 in real terms in the US. Today, there are only 4 new cars available at that price point. Clifford Winston notes allowing Chinese imports would likely increase that number to 11.

How Can Lower-Cost Foreign Vehicles Improve Car Affordability?

Core argument: Average new car prices reached $50,000, up from sub-$20,000 availability a decade ago, driving affordability crisis for budget consumers.

The average transaction price for a new car now sits around $50,000. In December, it became just about impossible to find one for less than $20,000. For anyone on a budget, an aging car is a trap. Auto repair costs jumped 15% in the last year alone, driven by the complexity of modern sensors and labor shortages. An average trip to the mechanic now costs roughly $840. To fix the problem, policymakers must overturn what has been for decades the third rail in American politics. It is time to stop coddling Detroit automakers [and open] the American market to cars made in China and elsewhere. Chinese cars aren’t just cheaper than the American alternatives. They’re often better. Take BYD’s slightly more upscale Seal sedan. It’s similar to Tesla’s Model 3, introduced nine years ago. But the Seal costs roughly $20,000 less than the Model 3. The Seal’s premium model offers substantially more horsepower, and its battery not only lasts longer, it can also be 80% charged in just 37 minutes. The Seal isn’t just a budget alternative; it is a more advanced machine.

Takeaways by Macro Roundup® AI

  1. Average new car prices reached $50,000, up from sub-$20,000 availability a decade ago, driving affordability crisis for budget consumers.
  2. Auto repair costs jumped 15% annually to $840 per visit, as sensor complexity and labor shortages result in escalating ownership.

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  • Inflation
  • China
  • GDP
    • Savings Glut/Trade Deficit
    • Trade (not deficits)
  • Politics

Inflation Is Down, But Americans Still Feel an Affordability Squeeze

Mark Niquette, Jennah Haque and Jade Khatib Bloomberg
Date Posted:
February 19, 2026
Is Database:
Database
Is Important:
Important

The US price level has risen 26% since January 2020, leaving Americans’ average weekly real wages up only 3.7% over five years.

The average American’s weekly pay has risen 31% over the past six years. That’s faster than prices across that period, so Americans in the aggregate aren’t losing ground — but inflation wiped out most of their income gains. For low earners, who saw the fastest wage growth after the pandemic, the last year or so has been tougher and they’re now lagging behind. [Grocery] prices are up about 30% since January 2020, about in line with average wage growth. But Americans had gotten used to paying roughly the same at the supermarket each week in the pre-pandemic years. Lately, they’ve been forced to stomach a bigger bill with almost every visit. A double-punch has pushed homeownership out of reach for many Americans: First the pandemic-era surge in prices, and then a steep run-up in mortgage rates. A young married couple now needs 70% of their annual household income to afford the average down payment, according to Goldman Sachs economist Elsie Peng, up from 58% in 2019 and 45% in 2000. [Further], the average principal and interest payment has doubled since early 2020, according to the National Association of Realtors. Employee premiums for family health insurance have risen 23% in the past five years to almost $6,900 on average. And more than 20 million people who rely on Affordable Care Act plans face a hike in their premiums after Congress let Covid-era subsidies expire.

Related Articles:

  • The Cost of Money is Part of the Cost of Living: New Evidence on the Consumer Sentiment Anomaly — US consumer sentiment is significantly lower than expected based on unemployment and inflation. Alternative measures of inflation that include borrowing costs…
  • Why Do We Dislike Inflation? — New survey research shows that people dislike inflation because they believe that it is associated with declining real wages and falling living standards…
  • A Mystery in Fixed Income — U.S. 10-year yields are higher today than at the start of the Fed’s cutting cycle in September 2024. Sløk notes that the “pattern of rising long-term interest…
  • Inflation
  • GDP
  • Monetary Policy
  • Politics
  • Workforce
    • Wages/Income
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