During the late 2010s, the Baltic states—specifically Estonia and Latvia—saw significant financial integration with Scandinavian banking groups. Highly integrated into Nordic capital networks, these rapidly modernising economies benefited from cross-border capital flows but remained highly vulnerable to monetary shocks from Stockholm and Zurich. By 2020, despite robust regional infrastructure, domestic credit growth was anaemic and private capital investment slumped.
A primary catalyst was the aggressive monetary intervention by the Swedish Riksbank and the Swiss National Bank, both of which had driven their benchmark policy rates deep into negative territory (reaching -1.25% at their troughs). Despite these sub-zero rates, Nordic parent banks chose to accumulate massive excess reserves and hold physical currency rather than extend new commercial credit. At the same time, household saving rates in the Baltic region actually ticked upwards, while business investment continued to contract. In response, these central banks initiated massive corporate bond buying schemes to bypass traditional bank lending channels.
Identify one piece of evidence in the stimulus material of the existence of a 'liquidity trap' and explain why it is an example of a liquidity trap.
