As confirmation, consider this LA Times report on surging bank deposits;
basically, people are holding monetary assets simply as a safe place to
park their wealth, and the banks have no desire to put those funds to
work.

You can also see this in the data. Look at the velocity of
M2 — the ratio of nominal GDP to Milton Friedman’s preferred measure of
the money supply. Monetarism rested on the assumption that there was a
reasonably stable relationship between M2 and GDP; what’s happening now
is that deposits are piling up but going nowhere, so velocity (which
rose in the 90s thanks to the rise of shadow banking) has plunged:

What
about inflation? First of all, the inflation question is to some extent
separate from the liquidity trap issue: you can be in a liquidity trap,
with conventional monetary policy ineffective, while still having some
inflation due to cost pressures.

That said, is inflation running
higher than I expected? Yes. Am I worried that this might be the
beginning of a runaway inflation process? No. Do I sound like Donald
Rumsfeld? Yes.

The IMF study of PLOGs
— prolonged large output gaps — pretty much summarizes my own views.
You expect a persistently depressed economy to have falling inflation,
although it tends to level out at a small positive number. There can be
episodes of rising inflation along the way, however, but these normally
reflect special and temporary factors, usually oil prices and/or
currency devaluation.

US experience mostly fits this pattern,
although I now believe that there’s an additional special factor that
isn’t typical: the prolonged slump in home construction has now created a
bit of a shortage, so rents are rising — and since implicit owners’
rent is a major part of core inflation, that’s causing a pickup over and
above the effects of oil prices.

But there remains no sign of a wage-price spiral — wages remain very weak:

I expect inflation to subside; so do investors.

However, fear of inflation remains a powerful factor among people with a strong influence on policy — as witness Paul Volcker’s op-ed today, which is a clear demonstration of just how hard it is to break out of this trap.

In
principle, monetary policy can still be effective even in a liquidity
trap — hey, I sort of wrote the book on that back in 1998. But that
effectiveness depends on expectations, on credibly promising higher
inflation over the medium term, so that sitting on cash becomes less
attractive. And that credibility is hard to achieve when even good guys —
and they don’t come much better than Volcker — insist on partying like
it’s 1979; not to mention the likes of Rick Perry threatening the Fed
with mob justice.

The belief that it would be hard to gain the kind of credibility we need for monetary effectiveness is why I and others, notably Mike Woodford, believed that a strong fiscal stimulus was the option most likely to work in clawing our way out of a liquidity trap.

Of
course, that didn’t happen either. So now people are once again hoping
that the Fed will save the day — even as it’s more likely, as Tim Duy says, that we’ll get some deck-chair rearrangement.