(Here it comes) The Austrian view;

Opposition to Keynes original description of the liquidity trap outlined in ”The General Theory” is well voiced, none more-so, than the Beranek and Timberlake 1987 critique. Empirical analysis looking at changes in sensitivity of money demand; comparing the Great depression (U.S 1930s); when interest rates were held at low values for prolonged periods of time compared to other periods, found there was no sensitivity increase when interest rates fell. In essence this suggests that no examples of the Liquidity Trap yet existed and that in conditions similar to those that Keynesian theory require for a liquidity trap to occur, the probability of a trap actually occurring was low.

There is less opposition to more modern descriptions of the Liquidity trap proposed by Paul Krugman in the late 1990s and his interpretation of Japan’s economic slump. His explanation is now widely accepted and held in regard by key Policy makers in Central banks around the globe, including the current chairman of the American Federal reserve Ben Bernanke.

However those of the Austrian school of thought have not remained silent on Japan’s slump, and of course offer their pragmatic no-thrills explanation. As Christopher Mayer (2004) explains Japan’s lost decade is simply part of the classic business cycle, but attributes actions taken by the Bank of Japan to its unique prolonged stagnation.

Mayer suggests that following the 1985 “Plaza Accord” the Bank of Japan was wrong to protect its exports by depreciating the Yen through increases in the money supply and cutting its discount rate by half. This resulted in economic “conflagration”, (the asset price bubble) as the creation of money and credit is not support by underlying capital. This inevitably leads to a bust, and the economy cannot correct itself until businesses and investment projects that were sustained by false capital are liquidated and resources and capital are directed to projects with greater profitability.

It follows then that Mayer continues to criticise interventions by the Japanese government and Bank of Japan to save those firms that were “too-big-to-fail”, and continue to try spend their way out of trouble though quantitative easing. Mayer cites such policies as stopping the market form “self-correcting” thus there is a prolonged period of stagnation.

This is widely considered an extreme view, and an argument that cannot easily be proven empirically but perhaps only be accepted by a change in philosophy.