What is a liquidity trap?
Deflation is the inverse of inflation, which should not be confused with disinflation. When deflation occurs, the government-issued nominal currency becomes more valuable as the purchasing power of the nominal currency increases with deflation. As this occurs, participants in the marketplace begin to realize that they can purchase more for their money, if they put off discretionary purchases to some future date. Each month that such purchases are forestalled, encourages a downward spiral in prices as merchants become increasingly motivated to sell their goods and services. This is the liquidity trap, which is very difficult for governments and central banks to resolve. It is generally agreed that Japan has been in a liquidity trap for the better part of the past decade. The increasing participation of China in global trade with its cheap work force is quickly becoming a major deflationary force.
