By Dan Kervick
In my recent post Escaping from the Friedman Paradigm, I noted the following remark by Paul Krugman on the way monetary policy ordinarily functions when interest rates have not fallen to the zero bound:
… people are making a tradeoff between yield and liquidity – they hold money, which offers no interest, for the liquidity but limit their holdings because they pay a price in lost earnings. So if the central bank puts more money out there, people are holding more than they want, try to offload it, and drive rates down in the process.
