As far as I inderstand a liquidity trap occurs when increasing the money supply is not able to stimulate the economy because people prefer hoarding the cash rather then investing in debt securities because of low yields. However will that not in turn cause the bond prices to drop and conseqeintly yields to rise due to lack of demand. And if so shouldnt these rising yields provide more and more incentive for people to start putting their money in bonds or other securities and thus solve the liquidity trap?

Thus my question is why are we not seeing this occur in places where a liquidty trap exists?


1 Answer 1


However will that not in turn cause the bond prices to drop

Low yields provide incentives for people to sell bonds in exchange for cash. And they do. However, bond prices will not drop if there is a counter-acting amount of buying. Who is that buyer? The various central banks that are causing the liquidity trap in the first place. If that sounds counter-intuitive, remember central banks are trying to stimulate the economy instead of running a trading operating that tries to maximize profits, and so it is not always in their interest to do the same thing other market participants do. If you're skeptical that central banks could do enough bond buying to counter-act the selling, take a look at the central bank of Japan (Bank of Japan). According to this Reuters article, they own 45% of the Japanese government bond market.


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