Investment trap

The investment trap is a basic concept of Keynesian economic theory . It describes the economic phenomenon that companies do not invest in times of depression even when interest rates are very low.

The reason for this is that the companies do not even utilize the existing production capacities; It would therefore be absurd to continue investing. Another reason for this is the relationship between expected returns on an investment and a security investment. Despite cheap credit / low bond yields, it may be better for companies to invest in “safe” securities than in “high risk” investments.

In addition to the liquidity trap and downwardly inflexible wages , this is where the cause of the Keynesian equilibrium in underemployment can be seen.

Investment and real interest rate in deflation

The real interest rate , which is calculated from the nominal interest rate and the (expected) deflation rate during deflation, is decisive for the investment . Both the long-term and the short-term real interest rate must be taken into account. The long-term real interest rate decides whether an investment is made at all; its return must exceed the long-term real interest rate. The short-term real interest rate decides whether the planned investment is started immediately or postponed due to an expected fall in the investment costs. If wages and prices are expected to fall, this means that the short-term real interest rate is very high. In a deflationary depression in particular, the expected return on an investment therefore rarely exceeds the short-term real interest rate. So investors will not borrow and hold their money in cash to benefit from deflation. John Maynard Keynes did not know the term real interest rate, but described its effects very precisely: Effects of real interest rates in deflation on the economy. With a very strong deflation, as in the Great Depression then entered the 1930s, every business owner would better leave his business to rest and wait for the fall of wages and prices to the low point.

Real interest rate in deflation and neoclassical

The IS-LM model of neoclassical synthesis taught at universities has not yet known any real interest rate and therefore does not represent Keynes' statements on deflation and its overcoming. It discusses the development of investment in connection with the money market interest rate of the LM function , i.e. the short term nominal interest. Therefore, in this model, the substantial stagnation of the investment in the case of drastically excessive real interest rates due to deflation can only be treated as interest inelasticity, because a further decrease in nominal interest rates (below zero) is no longer possible, the long-term nominal interest rate is still well above zero due to the liquidity trap and the real interest rate does not exist in the model. The IS curve is then shown in the model vertically above the Y-axis, although if the real interest rate is too high, the income of the economy is in free fall and, at most, an equilibrium real income below full employment income could very temporarily be assumed.

The problem with the real interest rate, which cannot be represented in the IS-LM model, but which determines the investment instead of the short-term money market interest rate, was discussed by David Romer.

In a deflationary depression like the global economic crisis, the real interest rate can be lowered by measures of the central banks to reflate, i.e. with rising wages and prices, until investment activity starts again as soon as the short-term and long-term real interest rate falls below the yield. The investment trap is therefore not a real interest rate inelasticity of the investment in deflation. As early as 1933, Irving Fisher explained that the central bank could prevent or end any depression by reflating the price level (raising wages and prices to the level before the outbreak of the crisis). In the event of a liquidity trap or when the nominal interest rate floor is reached, a central bank's ability to induce reflation may be limited.

Individual evidence

^ John Maynard Keynes: Social Consequences of Changes in the Value of Money (1923) in Essays in Persuasion , WW Norton & Company, 1991, p. 189: In the first place, Deflation is not desirable, because it effects, what is always harmful, a change in the existing standard of value, and redistributes wealth in a manner injurious, at the same time, to business and to social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive. But whilst the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result, there is another, more violent, disturbance during the period of transition. The policy of gradually raising the value of a country's money to (say) 100 per cent above its present value in terms of goods amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands, and to every one who finances his business with borrowed money that he will, sooner or later, lose 100 per cent on his liabilities (since he will have to pay back in terms of commodities twice as much as he has borrowed). Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process. It will be to the interest of everyone in business to go out of business for the time being; and of everyone who is contemplating expenditure to postpone his orders so long as he can. The wise man will be he who turns his assets into cash, withdraws from the risks and the exertions of activity, and awaits in country retirement the steady appreciation promised him in the value of his cash. A probable expectation of deflation is bad enough; a certain expectation is disastrous.
↑ Bernhard Felderer, Stefan Homburg : Macroeconomics and New Macroeconomics , Springer Berlin Heidelberg 2005, pp. 148f
↑ Bernhard Felderer, Stefan Homburg : Macroeconomics and new macroeconomics , Springer Berlin Heidelberg 2005, p. 149f
^ David Romer: Keynesian Macroeconomics without the LM Curve (PDF; 184 kB) p. 150
↑ Irving Fisher: The Debt-Deflation Theory of Great Depressions (PDF; 2.5 MB), Econometrica, p. 346

[1] John Maynard Keynes: Social Consequences of Changes in the Value of Money (1923) in Essays in Persuasion , WW Norton & Company, 1991, p. 189: In the first place, Deflation is not desirable, because it effects, what is always harmful, a change in the existing standard of value, and redistributes wealth in a manner injurious, at the same time, to business and to social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite. In particular it involves a transference from all borrowers, that is to say from traders, manufacturers, and farmers, to lenders, from the active to the inactive. But whilst the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result, there is another, more violent, disturbance during the period of transition. The policy of gradually raising the value of a country's money to (say) 100 per cent above its present value in terms of goods amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands, and to every one who finances his business with borrowed money that he will, sooner or later, lose 100 per cent on his liabilities (since he will have to pay back in terms of commodities twice as much as he has borrowed). Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process. It will be to the interest of everyone in business to go out of business for the time being; and of everyone who is contemplating expenditure to postpone his orders so long as he can. The wise man will be he who turns his assets into cash, withdraws from the risks and the exertions of activity, and awaits in country retirement the steady appreciation promised him in the value of his cash. A probable expectation of deflation is bad enough; a certain expectation is disastrous.

[2] Bernhard Felderer, Stefan Homburg : Macroeconomics and New Macroeconomics , Springer Berlin Heidelberg 2005, pp. 148f

[3] Bernhard Felderer, Stefan Homburg : Macroeconomics and new macroeconomics , Springer Berlin Heidelberg 2005, p. 149f

[4] David Romer: Keynesian Macroeconomics without the LM Curve (PDF; 184 kB) p. 150

[5] Irving Fisher: The Debt-Deflation Theory of Great Depressions (PDF; 2.5 MB), Econometrica, p. 346