Will the Eurozone Avoid a Liquidity Trap?

Will the euro-zone avoid a liquidity trap? - at www.moneyweek.com - the best of the international financial media

From time to time we hear suggestions that the eurozone economy is about to fall into a liquidity trap'. Indeed, this risk is still advanced as a reason for the ECB to cut interest rates. How seriously should we take this threat?

Keynes first talked about a liquidity trap in the context of the bond market. However, the concept now has a more general meaning. It is often used to describe a situation where companies expect such low returns that they do not think it is worth borrowing to invest, and where consumers expect prices to fall and would therefore rather hold cash than spend. This is a particular problem when inflation is already very low, or negative (i.e. deflation). The cost of borrowing represented by real interest rates (nominal rates minus expected inflation) may then be too high, even if nominal interest rates are also low.

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