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The Keynesian Liquidity Trap: An Austrian Critique

22 Pages Posted: 17 Oct 2015 Last revised: 19 Nov 2015

Peter J. Boettke

George Mason University - Department of Economics

Patrick Newman

Florida Southern College

Date Written: October 15, 2015

Abstract

This paper critiques the Keynesian liquidity trap from an Austrian perspective. The liquidity trap theory argues that at a given interest rate the demand for money is horizontal, and interest rates cannot fall to stimulate investment. The major problem in the theory is that it concentrates on the loan interest rate instead of the price spread in the structure of production, called the natural rate, which as the Austrians have argued is the true interest rate determined by time preferences that the former is only a reflection of. Loan interest rates do not fall because individuals expect the price spread to rise. The rising price spread represents the healthy market correction from a prior boom when interest rates were artificially lowered and must occur for a sustainable recovery. Barring rigid prices from government intervention, which prevent the necessary market adjustments, the liquidity trap does not pose a problem for the free market economy.

Suggested Citation

Boettke, Peter J. and Newman, Patrick, The Keynesian Liquidity Trap: An Austrian Critique (October 15, 2015). GMU Working Paper in Economics No. 15-52. Available at SSRN: https://ssrn.com/abstract=2674873

Peter J. Boettke

George Mason University - Department of Economics ( email )

4400 University Drive
Fairfax, VA 22030
United States
703-993-1149 (Phone)
703-993-1133 (Fax)

Patrick Newman (Contact Author)

Florida Southern College ( email )

Lakeland, FL 33801
United States

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