In the Financial Times from November 2 2020, the IMF chief economist Gita Gopinath suggested that world economies at present are likely to be in a global liquidity trap. Gopinath has reached this conclusion because the yearly growth rate of the price indexes has been trending down despite very low interest rates policies. According to the IMF chief economist, central banks have lowered interest rates to below 1 percent and in some countries interest rates are at present negative. In the framework of a liquidity trap, it is held that the ability of central banks to stage an effective defense against various economic shocks weakens significantly. So how then can one resolve the problem of the central banks inability to produce the necessary defense of the economy?
A possible way out of the liquidity trap suggests Gopinath, is to employ aggressive loose fiscal policy. This means an aggressive government spending in order to boost the aggregate demand.
According to Gopinath,
Fiscal authorities can actively support demand through cash transfers to support consumption and large-scale investment in medical facilities, digital infrastructure and environment protection. These expenditures create jobs, stimulate private investment and lay the foundation for a stronger and greener recovery. Governments should look for high-quality projects, while strengthening public investment management to ensure that projects are competitively selected and resources are not lost to inefficiencies.
Furthermore, according to Gopinath,
The importance of fiscal stimulus has probably never been greater because the spending multiplier — the pay-off in economic growth from an increase in public investment — is much larger in a prolonged liquidity trap. For the many countries that find themselves at the effective lower bound of interest rates, fiscal stimulus is not just economically sound policy but also the fiscally responsible thing to do.
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