The Sorry State of the Economy

Brad DeLong has written an excellent article on the current economic situation -- the liquidity trap -- that the US finds itself in. It is written in a style accessible to everyone and everyone should read it. The conclusion is simple: the US needs more stimulus to get out of this current depression. Here is just a bit from that article:

But when rates become so low that there’s little difference between cash and short-term government bonds, open-market operations cease having an effect; they simply swap one zero- yielding government asset for another, with their hunger to hold more safe, liquid assets unsatisfied.

This is the liquidity trap.

In this situation we need deficit spending. The government spends and borrows, creating more of the safe, cashlike assets that private investors want. As these bonds hit the market, people who otherwise would have socked their money away in cash -- diminishing monetary velocity and slowing spending -- buy bonds instead. A large, timely government deficit thus short- circuits the adjustment mechanism, avoiding the collapse in monetary velocity.

Hicks’s conclusion: As long as output remains depressed and there is slack in the economy, printing more bonds will have negligible effect in increasing interest rates.

I had read Hicks. I even knew Hicks. But I thought that his era, the Great Depression, had passed. Sitting in my first graduate economics class in 1980, I listened to Marty Feldstein and Olivier Blanchard -- two of the smartest humans I am ever likely to see -- assure me that Hicks’s liquidity trap was a very special case, into which the economy was unlikely to wedge itself again. Yet it did.

On my shelf is a slim, turn-of-the-millennium volume by Paul Krugman titled “The Return of Depression Economics.” In it he argued that we mainstream economists had been too quick to ditch the insights of Hicks -- and of economists Walter Bagehot and Hyman Minsky. Krugman warned that their analysis was still relevant, and that if we dismissed it we would be sorry.

I am sorry.

Go read the whole article.

The great tragedy of today is that politicians around the world have turned a deaf ear to the lessons of the Great Depression and are busy recreating the same mistakes that turned the panic of 1929 into the Great Depression of 1929-1941, a lost decade (and in the case of Japan in 1989, the lost decades).

What I find despicable is that economists who should know better, but whose political views are right wing, are purposefully confusing policy makers by throwing out misleading and fundamentally wrong statements that simply muddies the water and allows the Andrew Mellons of today to call for:

Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.

Guess what? Mellon's hopes were fulfilled. The American people went through the hell of the 1930s and of course the country became morally stronger for the experience. It was all worthwhile, right?

Funny how people with piles of money can be so "moral" about issues like high unemployment and people being thrown out of their houses. I think Jesus had some similar economic commentary, something about finding a mote in the other guy's eye while ignoring the beam in your own eye. Moral hypocrisy and bad economics have always been with us from time immemorial and getting a rich man into heaven is harder than getting a camel through the eye of a needle. Why? Because they are too busy lecturing us on the high moral value of "austerity". That and cornflakes are guaranteed to give you a sound constitution.