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Summary
- Federal Reserve (Fed) could be getting into a liquidity trap
- Fed Chairman, Jerome Powell said last week that America is officially trapped below zero
- After making all the efforts to keep the businesses and consumers boosted through quantitative easing, it could manifest into liquidity crisis
After following Japan in the quantitative easing trend, Federal Reserve is now going the Japanese way in terms of liquidity trap. Liquidity trap is a situation in which monetary policy is unable to lower nominal interest rates because it is already close to zero. Last week, Federal Reserve’s Governor, Jerome Powell made a statement saying that America is officially trapped below zero.
The liquidity crisis that Jerome Powell was talking about is a financial condition described by a lack of cash or assets that can’t easily be converted to cash with the financial institutions. This can be caused by increase in demand of liquidity and shortage in supply of liquidity.
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What is Liquidity Crisis?
Liquidity crises are usually triggered by large economic downturns due to some major event that impacts the economy but can also be caused by the normal changes in economic cycles. In this case it is the COVID-19 led economic downturn that has moved the United States towards this crisis. Due to the pandemic several businesses closed, event cancellations and restrictions on movement led to an economic crisis. So, the Fed stepped in to keep the economic damage to a minimum level, announcing giving stimulus packages of various amounts starting with US$2.3 trillion. It vowed to keep giving the stimulus till the Country was on the path of recovery.
It did whatever it could to keep the economy boosted including slashing interest rates to nearly zero, establishing credit facilities for businesses and consumers and purchased unlimited amounts of bonds. However, despite the Fed’s moves, there could be shortages of corporate debt and other kinds of liquidity that could manifest into a bigger crisis, if COVID-19 bubble continues in the year 2021. However, a crisis occurs when many financial institutions experience a liquidity shortage alongside each other and sell off their assets and try to get short-term debt from the credit markets.
This is exactly what Powell was hinting at when last week he said that America is officially trapped below zero.
