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Economic Commentary

Foreign Exchange and the Liquidity Trap

When short-term interest rates hover near zero, central banks may have difficulty offsetting downward momentum on prices and economic activity through traditional monetary policy channels, since commercial banks have little incentive to make loans. Economists refer to this situation as a liquidity trap. Do exchange rate targets and foreign exchange operations, as some have suggested, offer a way to escape such a trap?

The views authors express in Economic Commentary are theirs and not necessarily those of the Federal Reserve Bank of Cleveland or the Board of Governors of the Federal Reserve System. The series editor is Tasia Hane. This paper and its data are subject to revision; please visit for updates.

Suggested Citation

Humpage, Owen F., and William Melick. 2003. “Foreign Exchange and the Liquidity Trap.” Federal Reserve Bank of Cleveland, Economic Commentary 10/1/2003.

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