A liquidity trap is when any form of injections of cash into private sectors by central banks fails to decrease interest rates and make monetary policy effective. This is a Keynesian economics concept. Many people do think currently we may enter the so-descirbed "liquidity trap", as real interest rates in some countries have already been negative and there is no room to decrease interest rates further. However, we can see some banks take some unorthodox actions, charging negative deposit interest rates on individual and corporate accounts. This by definition denies the opinion of we are entering a liquidity trap, as the interest rates have been brought down by the current monetary policies and will definitely have a lot of effects on our consumption behavior, investment behavior and the economy in general. Therefore, I believe we are not entering a liquidity trap.
How do central banks pump cash into economies? This question is simple and does not give what we really want. The real question we want to know is how central banks boost their money supply. The answer is clear, the quantitative easing program. The quantitative easing is central banks buy assets from the markets, the money spent by central banks is the hot money central banks want to pump into the economies. When does it work? It works when assets are generally dumped by the investors during economic recession periods. However, when central banks are trying to buy some safer assets, there comes the problem. For example, the Bank of England tries to buy government bonds from institutions and some offers get rejected. Therefore, we can see that the assets central banks can buy via their quantitative easing programs are usually those rubbish grade assets. Such programme I think is not efficient to boost investment. Selling bad assets to central banks is cutting losses rather than gaining more profits. So investors will not boost their investment, as the market uncertainty still exists and they are not sure if such good luck could come again. The best result is investors do not reduce their investment level as their losses have been covered by the central banks. I think central banks' quantitative easing program may best described as "rubbish cleaning programs" that they clean up the rubbish assets holding in the investors' hands and replace them with cash.
Such "rubbish cleaning programs" can hardly boost the economy, all it can achieve is to create some safe net for the financial sector, just like the concept of minimum wage. The action of buying government bonds and foreign currencies via the quantitative easing program may have the worst outcomes. When uncertainty happens, the US 10 yr bonds and the UK 10 yr gilt are the top two safe investment choices, the market is hot and does not need the intervention of the central banks. The buying action could only lift up the bond prices and make the market even hotter. To boost the economy, you do not want to see all hot money flowing into the government bond market, what you want to see is an increase in the general investment level.
I think the central banks may not boost up the market confidence by offering their quantitative easing programs, but they can use the quantitative easing program to create some really detailed guidance of the economy. When central banks could be like investors when they are carrying out their quantitative easing programs. They could guide the market investment focus. For example, if a central bank thinks the economy needs to improve its infrastructure, then it could buy assets of the infrastructure sector via its quantitative easing program and draw the market attention to this market. So the central bank has the ability to guide the market behavior by taking actual actions. Moreover, in the future, when the market confidence is restored, central banks can sell their assets, and because central banks act like investors, the assets could be sold without significant devaluation and the money created by the quantitative easing program is recalled from the market, so people do not need to worry about a blowout of oversupply of money occurs when all hot money becomes active.
To conclude, I think that the quantitative easing program should be carried out by central banks as a program of guiding the market investment instead of cleaning up the mess created by the market. The option of buying the safe assets is the worst option, as it may make the market think that even the central banks believe the government bond is the only investment option at the moment. Therefore, I think that central banks should act more like a wise investor rather than a cleaner in the market.
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