Introduction
The liquidity trap is not merely a technical flaw in macroeconomic models, but a fundamental limit to the rationality of economic management. This article analyzes the moment when traditional central bank tools lose their efficacy and monetary policy becomes powerless against market paralysis. Readers will discover how the labor market and institutions shape medium-term equilibrium, and why the modern challenges facing the NBP and ECB require moving beyond conventional thinking regarding interest rates.
The Liquidity Trap: Absolute Demand for Money and Policy Impotence
In the Keynesian tradition, the liquidity trap describes a state in which nominal interest rates fall to near-zero levels. Under these conditions, the demand for money becomes infinitely elastic—economic agents, seeing no opportunity cost, hoard cash instead of investing. The LM curve thus takes a horizontal form, meaning that increasing the money supply no longer lowers its price.
The essence of the problem is captured by the horse to water metaphor: a bank can provide cheap capital but cannot force firms to "drink"—that is, to engage in real economic activity. The logical puzzle of monetary expansion explains this paradox: if an increase in the money supply does not translate into production, it means the transmission mechanism has been severed at the level of interest rates, which can no longer be lowered. This is the functional limit of the model, where traditional demand stimulation ceases to work.
The Labor Market and the AS–AD Model: The Mechanism of Returning to Equilibrium
When demand-side policy fails, the labor market becomes crucial. It is here, through the relationship between wage setting (establishing nominal wages based on price expectations and bargaining power) and price setting (setting prices as a markup over costs), that real equilibrium is forged. The natural rate of unemployment is not a physical constant but an institutional outcome—it depends on labor laws, benefits, and market structure.
The AS–AD model serves as a procedure for reconstructing this equilibrium, linking demand with supply-side discipline. Paul Krugman suggests that in a liquidity trap, a central bank must "credibly promise to be irresponsible"—that is, create expectations of future inflation to stimulate spending. Conversely, Hyman Minsky points out that the trap is often a balance sheet crisis: when debt repayment is the priority, even zero interest rates will not encourage risk-taking. In an open economy, the situation is further complicated by interest rate parity, which links domestic policy to global capital flows and exchange rates.
NBP vs. ECB: Sovereignty and Institutional Challenges
Since 2004, the National Bank of Poland (NBP) has assumed the role of a frontier institution, balancing monetary sovereignty with EU integration. The strategy of direct inflation targeting (DIT) became an anchor for expectations, stabilizing the economy despite external shocks. Thanks to the floating exchange rate of the zloty, the NBP could act as a shock absorber, as evidenced by the lack of recession after 2008 and the response to the pandemic through asset purchases.
However, there is an ontological difference between the NBP and the European Central Bank (ECB). The NBP is the bank of a nation-state, whereas the ECB is a "bank without a state," managing a common currency for diverse economies without a shared fiscal backbone. For the ECB, the liquidity trap is an existential challenge—price stability must substitute for a lack of political unity, which, under interest rate paralysis, drastically limits maneuvering room and forces risky, unconventional measures.
Summary
The liquidity trap proves that economics is not a mechanism but a complex social system. When traditional instruments fail, the solution lies in supply structure and institutional reforms. In a world of low rates and balance sheet crises, can the economy permanently drift toward dormancy? Or perhaps this is the moment for economics to meet ethics, seeking new development models where cheap money is no longer the sole substitute for productivity.
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