Monday, May 7, 2012

So it has come to this

Brad DeLong says:
But I must say I never expected to see anything like this in a fiat-money managed-currency world. Yes, I knew that under a gold standard things like this could happen: that by itself was sufficient reason to drop the gold standard. But I never imagined that central bankers claiming to be technocrats would wedge the economy here, and then refuse to take the actions they could take to get us out, and that fiscal authorities would similarly shy at the jump, and that banking and housing regulators would sit on their hands as well…

He summarizes my thoughts exactly.  Back in 2005, I took intro Economics, with Professor Richards, and I was a piss-poor student.  I thought I was above it all, and I never really took the time to understand IS/LM (yes, that's the core of macro, did I mention I was a bad student?).  AND YET I could easily grasp the concept of a liquidity trap, couldn't fully understand how Japan had spent the better part of two decades without the will to extract itself from one, and thought we would never let such a disastrous thing happen in America.  Whoops.

To review:
The Central Bank controls the economy by controlling the prevailing interest rate.  Rate goes up, economy slows down, rate goes down, economy speeds up.  If the the Central Bank puts the pedal to the metal (ie, rate of zero) and you still have a recession, you're in a liquidity trap, and it's time to start throwing money out the door through whatever means necessary, and then you can start pulling back some of that liquidity when the economy recovers.  The prevailing intrest rate has been zero for the past for years or so, and yet none of this is happening.

Worrying about inflation in the middle of a depression is like seeing your house is on fire and not calling 911 because they might get your house wet with their fire hoses.  Except less so, since loose money in a depression won't cause inflation, whereas the fire department will definitely flood your lawn.

(If you think this comparison might be a bit shrill, consider this: Our output gap amounts to about 300 Billion of output that we could be making, but aren't.  Every year fire destroys maybe 10 or 20 billion dollars in property.  The cost of this recession is far worse than the collective cost of structure fires)

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