BANKING DEREGULATION AND LIQUIDITY TRAP DILEMMAS
Krugman (2009) explains that the recession that struck the United States in the late 2000s was mainly the result of policy failures within the nation’s financial system. One of the policy changes that Krugman blames for the collapse is the repeal of the Glass-Steagall act in 1999. Through the legislation, commercial banks were barred from combining their operations with investment banks (Krugman 2009, 163). Krugman claims that this move sent the nation’s financial system in the wrong direction by causing the commercial banks to engage in risky behavior. However, Krugman places most of the blame on the government’s failure to control the shadow banking system. He argues that the conduct of non-depository banks was crucial to the system’s collapse, meaning that the government can be held responsible for failing to come up regulations for the sector (Krugman 2009, 160).
One of the
key issues that Krugman looks at in his book is the liquidity trap. He
describes this as a situation where people are unwilling to spend their money
in anticipation of a significant event (Krugman 2009, 71). Low interest rates
are some of the characteristics that typify a liquidity trap as witnessed right
before the recession. Kennedy (2000) adds that liquidity and inflation go hand
in hand with the dynamics making it possible for one to destabilize the other
(191). One of the solutions that Krugman (2009) suggests is a devaluation of
the currency after specific periods to take away the incentive that people have
for hoarding their money (74). Such as system of would provide an incentive for
people to spend their money even in times of uncertainty. Using his
baby-sitting coop analogy, Krugman (2009) explains that the devaluation, though
unfair, would drive people to spend money as soon as they earn it instead of
keeping it in anticipation of future events (76). This devaluation will
increase the risk of people losing some of their money if they fail to spend it.
Kennedy, Peter E. 2000. Macroeconomic essentials: understanding economics in the news. Cambridge, Mass.
: MIT Press.
2009. The Return of Depression Economics
and the Crisis of 2008. New York.
W. W. Norton and Company Inc.