Krugman introduces the notion of a liquidity trap in his analysis of Japan in the 1990s, the Asian financial crisis, Latin American crisis and the 2008 Global Financial Crisis. Liquidity traps are essentially a lack of circulation or growth in the supply of money in the economy. Krugman argues that liquidity traps are caused by aggregate demand failures and produce negative natural interest rates. Krugman identifies how misguided austerity measures with low interest rates led to the liquidity trap in 2008,while large foreign denominated debt held by the private sector in Asia and Latin America led to the economic contraction. Similarly, Krugman attributes the deregulation of the financial markets in Japan for the liquidity crisis. Regardless of the cause, Krugman highlights that monetary policy in such circumstances is ineffective given the economy is already at the zero lower bound (very low interest rates).Therefore, Krugman argues that policy should target increasing the rate of consumption and inflationary expectations to increase long run money supply.
