Abstract:

This paper is an analysis of two modern-day examples of liquidity traps: the US in 2008 and Japan from the 2000s through to 2008. The two countries used drastically different responses with the US combining monetary and fiscal policy and Japan relying solely on monetary policy, including negative interest rates. This paper will examine the key indicators of a liquidity trap being a recessionary market combined with high unemployment and general distrust in the banking system. Following that, we then break down the various tactics used to push each country out of their respective liquidity traps and provide a comparison of the two tactics. We ultimately conclude and argue that it is necessary to use a combination of monetary and fiscal policies to rebuild trust in the banking system and reinvigorate investment and consumer spending as those are at the root of the liquidity trap.