Journal of Economic Literature
ISSN 0022-0515 (Print) | ISSN 2328-8175 (Online)
Liquidity Traps: A Unified Theory of the Great Depression and the Great Recession
Journal of Economic Literature
(pp. 1424–1551)
Abstract
This review of liquidity traps unifies three landmark economic downturns—the US Great Depression, the Great Recession, and Japan's Long Recession—into a single analytical framework. We examine various forces that drive natural interest rates negative: temporarily (such as banking crises and debt overhangs) or permanently (such as demographic shifts and inequality). When policy rates hit the zero lower bound, conventional monetary tools lose traction. Under a standard monetary policy regime, counterintuitive paradoxes emerge: Greater price flexibility deepens recessions, and positive supply shocks become contractionary. We show how policy effects—including the size of fiscal multipliers, forward guidance, and these paradoxes—depend critically on the monetary-fiscal regime and on central bank credibility. The paper explain show regime changes, such as Franklin D. Roosevelt's 1933 abandonment of the gold standard and balanced-budget dogmas, successfully reversed deep slumps by credibly shifting expectations. We examine whether secular-stagnation forces are likely to assert themselves in the coming decades.Citation
Eggertsson, Gauti B., and Sergei K. Egiev. 2025. "Liquidity Traps: A Unified Theory of the Great Depression and the Great Recession." Journal of Economic Literature 63 (4): 1424–1551. DOI: 10.1257/jel.20241306Additional Materials
JEL Classification
- E23 Macroeconomics: Production
- E42 Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems
- E43 Interest Rates: Determination, Term Structure, and Effects
- E52 Monetary Policy
- E62 Fiscal Policy
- G01 Financial Crises
- G21 Banks; Depository Institutions; Micro Finance Institutions; Mortgages