Structural Traps, Politics and Monetary Policy

Structural conditions pose a challenge to monetary policy, as the example of Japan shows. In this paper we develop the concept of structural trap, where the interplay of long-term economic development incentives, politics, and demographics results in economies being unable to effi-ciently reallocate capital from low- to high-return uses. The resulting macroeconomic picture looks like a liquidity trap – low GDP growth and deflation despite extreme monetary easing. But the optimal policy responses are very different and mistaking them could lead to perverse results. The key difference between a liquidity trap and a structural one is the role of politics. We show how, in the Japanese case, longstanding economic incentives and protections and demographic trends have resulted in a political leadership that resists capital reallocation from older protected low-return sectors to higher-return newer ones. If the Japanese case is instructive, in a structural trap, extremely loose monetary policy perpetuates deflation and low GDP growth, becaus