The world's in a 'global liquidity trap'. What does that mean for Australia?


Last week, something notable occurred.


Two days out from the US presidential election, the chief economist of the International Monetary Fund issued a warning.


She said the global economy was in a "liquidity trap".


"For the first time, in 60 per cent of the global economy — including 97 per cent of advanced economies — central banks have pushed policy interest rates below 1 per cent. In one-fifth of the world they are negative," Gita Gopinath warned.


"With little room for further rate cuts, central banks have deployed unconventional methods.


"Despite this effort, persistently low inflation — and in some cases intermittent deflation — has raised the spectre of further monetary easing to achieve negative real rates if another shock strikes.


"It has led to the inescapable conclusion that the world is in a global liquidity trap, where monetary policy has limited effect.


"We must agree on appropriate policies to climb out," she said.


Ms Gopinath's warning was published in the Financial Times, the 132-year-old organ of the world's financial elite.

A day later, the Reserve Bank of Australia cut its cash rate target from 0.25 per cent to 0.1 per cent — the lowest in our history.


It also launched a $100 billion "quantitative easing" program to drive down interest rates across the whole structure of Australia's economy, and to depress the value of Australia's dollar.


The day after that, the US presidential election took place and much of the world's attention has been fixated on the results of that historic election ever since.


But we'll have to come to terms with Ms Gopinath's warning — because if she's correct, the implications for Australia could be profound.



So, what's a 'liquidity trap'? And how will it affect Australian households?


Essentially, a liquidity trap is a situation in which interest rates become so low that monetary policy has limited effect.


We've seen evidence of the phenomenon here.


For the past nine years, the RBA has been consistently cutting interest rates.


The cash rate target was 4.75 per cent in 2011, it's now 0.1 per cent, but inflation has been weakening for years.


And last week, the RBA announced it would start buying hundreds of billions worth of Government bonds to pull interest rates lower, and to weaken the currency.</