a theoretical curiosity rather than a practical problem likely to confront policymakers. but with short - term rates now at zero in japan and low inflation almost everywhere in the industrialized world, the problem is taken more seriously by central banks – to the point that it was one of the topics at jackson hole. keynes ’ views on the liquidity trap have, in my view, often been misunderstood. keynes understood that central banks could push rates on short - term government debt to zero. the liquidity trap, as keynes used the term, is better thought of as a term - structure trap or, more generally, a limit on how low long - term and private interest rates can go once the interest rate on short - term government debt is pushed to zero. when short - term government rates reached zero, keynes believed that there would still be positive interest rates on both longer - term government securities and private debt and that monetary policy then would be unable to push those rates any lower. the conventional view is that the level of long - term rates is determined by current and expected shortterm rates. given that market participants are unlikely to expect that zero short - term rates will be sustained for 20 or 30 years, the maturity of long - term bonds, rates on long - term securities will remain positive when short - term rates reach zero. stated somewhat differently, shocks that would otherwise lower short - term rates cannot do so at the zero bound, while shocks that would raise short - term rates still will do so. in addition, private rates differ from government rates by an amount that reflects the risk of default on private debt, assuming that government debt is viewed as being default free. even if the rate on government debt reaches zero, therefore, private debt will still carry positive rates. the liquidity trap is sometimes referred to as the problem of the zero bound on nominal interest rates. nominal interest rates cannot be negative, because, in this case, everyone would want to hold cash. consequently, an environment of very low inflation would constrain how low monetary policy could push real interest rates in response to a recession and, therefore, be associated with less - favorable cyclical performance of the economy. if inflation were 2 %, for example, monetary policy, by driving the nominal interest rate to zero, could push real interest rates to minus 2 %. if prices were stable, on the other hand, the limit on the real interest rate would be zero, and this limit might constrain the ability of monetary policy

imparting pressures on prices in the united states. in the recent economic environment, however, the widening of the trade and current account deficits had some beneficial aspects. it provided a safety valve for strong u. s. domestic demand, thereby helping to restrain pressures on u. s. resources. it also cushioned, to some extent, economic weakness in our trading partners. moreover, decreasing import prices, which partly came from the appreciation of the dollar through mid - summer, contributed to low overall u. s. inflation, as did ample manufacturing capacity in the united states and lower prices for oil and other commodities stemming from the weak activity abroad. the marked drop in energy prices significantly contributed to the subdued, less than 1 percent, increase in the price index for total personal consumption expenditures during 1998. in addition, supported by rapid accumulation of more efficient capital, the growth of labor productivity picked up last year, allowing nominal labor compensation to post another sizable gain without putting added upward pressure on costs and prices. i shall return to an analysis of the extraordinary performance of inflation later in my remarks. the federal open market committee conducted monetary policy last year with the aim of sustaining the remarkable combination of economic expansion and low inflation. at its meetings from march to july, the inflation risks accompanying the continued strength of domestic demand and the tightening of labor markets necessitated that the fomc place itself on heightened inflation alert. although the fomc kept the nominal federal funds rate unchanged, it allowed the real funds rate to rise with continuing declines in inflation and, presumably, inflation expectations. in august, the fomc returned to an unbiased policy predilection in response to the adverse implications for the u. s. outlook of worsening conditions in foreign economies and in global financial markets, including our own. shortly thereafter, a further deterioration in financial market conditions began to pose a more serious threat to economic stability. in the wake of the russian crisis and subsequent difficulties in other emerging market economies, investors perceived that the uncertainties in financial markets had broadened appreciably and as a consequence they became decidedly more risk averse. safe - haven demands for u. s. treasury securities intensified at the expense of private debt securities. as a result, quality spreads escalated dramatically, especially for lower - rated issuers. many financial markets turned illiquid, with wider bid - asked spreads and heightened price volatility, and issuance was disrupted in some private securities markets. even the liquidity in