Monetary policy in the United States – the Fed in the interest-rate trap?

Since the stock market collapse at the beginning of 2000, the Fed has attempted to stabilise the American economy by providing it with massive liquidity. A major motive was the fear that the American economy could fall into a liquidity trap. Motivated by the conviction that the best strategy is taking timely counter measures, the Fed pursued an aggressive policy of repeated interest rate reductions. The money market interest rate sank to a current 1%, the lowest level in almost 50 years. In the meantime, more and more voices are warning that an over-provision of liquidity by the Fed contributes to an over-valuation of stock-market and real-estate prices. The low interest rates encourage excessive indebtedness and bear the danger that structural imbalances could build up that in future could result in a higher vulnerability to crisis of the American economy. Prof. Gerhard Illing, Munich University, shows in this article that the greatly increased indebtedness of the private sector makes American households more susceptible to fluctuations in interest rates, incomes and real estate prices. It cannot be ruled out that the Fed, instead of facing a liquidity trap, now stands before the reverse problem, an interest rate trap – the danger that faced with growing indebtedness a rise in interest rates could cause seriously negative effects on consumption, which means that the scope for monetary policy will be strongly limited in future.