The big problem with a huge Keynesian Band-Aid is that it’s never worked for major economic crises, ever. Including the Great Depression.
No, I’m not assuming zero inflation. There is no need to assume zero inflation. I’m just compensating for inflation.
I’m talking about real GDP, not nominal GDP. For my purposes here, I don’t care overmuch about what the inflation rate will be in 2009. It’s an important number, but it’s not relevant to the current discussion in the way you seem to think. We can use 2007 dollars or 2008 dollars to measure the total output produced in 2009 in order to compensate for any price increases and get real GDP values. This is standard procedure. It is almost never useful to use nominal values to compare GDP across years, even during good economic times.
This means that my discussion here is only about the total amount of stuff that’s produced each year. In 2007 we produced approximately 13.8 trillion dollars worth of stuff (using 2007 dollars). In 2009, we might produce, say, only 13 trillion dollars worth of stuff (using 2007 dollars). When real GDP decreases like that, it’s an economic contraction, a recession. And this is going to be a bad recession. Maybe the nominal value will be much higher than that, but I don’t care about the nominal value. I care only about real output that we produce, real GDP.
To get stuck at a lower-than-optimal GDP would be costly beyond belief, so we should try to fix it. One such way is to create a little inflation–not for inflation’s sake (which might not have been clear in my other post), but to encourage people to spend their money instead of holding on to it. If we start losing a nickel off of every George Washington we’re holding, then we’ll have an incentive to start buying things and investing again to avoid that loss in wealth. This additional incentive to spend is exactly the sort of thing we need to pump up the economy again. Ben B is an expert on the Depression. He knows what’s what, so he’s been “printing money” just as he should, but nobody is spending. This is why the large increase in the monetary base hasn’t resulted in inflation. But I’m sure that Bernanke will continue to look for innovative ways of quietly making money until we have some healthy inflation that will help us grow again.
And while it’s technically correct that our previous growth wasn’t sustainable (because, after all, it didn’t sustain), even so, an economy that is not employing its workforce is an economy that is wasting its potential. There is no reason that these people shouldn’t be put to work, either directly or indirectly, doing something else. There is a cost associated with people learning new skills and shifting to new lines of work, but if we pay for those sorts of costs up front, then we can reap the benefits of full employment later. We can return to the days of steady growth. Smart policy means doing something to achieve full employment again, sooner rather than later. We need a mix of expansionary monetary and fiscal policy, and we need it now.
Unfortunately, those currently in power are mostly incompetent. We have to wait another month and likely lose another half million jobs in the meantime. It is disgraceful.
We sustained real GDP growth of over 5% for six consecutive years with increased deficit spending right before and during WWII. Three of those six years we had real GDP growth of over 15%. In 1942-43, we got damn close to 20% growth. And these phenomenal growth rates were attained despite extensive wartime controls of the economy. If we had used big stimulus without those controls, it’s quite likely that demobilization after the war wouldn’t have been so painful (though, of course, the war rightly took precedence).
Keynesian stimulus works. It has been proven to work in the real world, and the economic theory that underlies it remains, to this day, the very foundation of macroeconomics. There is room for disagreement about the size of the needed stimulus, but there is no real doubt about the basic economics. To deny that is to trust the experience and beliefs of the 1920s over the decades of research and history since.
If a large increase in the monetary base hasn’t induced spending, why should one believe that a further increase will necessarily help? Just how far do you propose the money supply be expanded? In the span of three months, the monetary base has grown by about $630 Billion to $1.5 Trillion. You cannot just create money at this high a rate and expect that there won’t be damaging inflationary consequences. Meanwhile, saving is up modestly. The banks are hoarding cash in preparation for further asset write-downs. People are afraid.
Losing 533,000 jobs in a month is terrible, no question. But doing something, anything, isn’t necessarily better than doing nothing. You can cause quite a lot of damage by just doing something without carefully considering the consequences of your actions. We threw a bunch of money at the problem, and it didn’t generate the desired effect. It’s possible that throwing more money at the problem may not be the most appropriate solution in this particular case at the present time.
We got into this mess because we were collectively overleveraged and now we need to unwind. This just takes time.
With respect to monetary policy, I’m not proposing anything. I’m just trying to explain, as best as I’m able, what might be going through Bernanke’s head. He wants some healthy inflation, and he’s willing to experiment to get it. I admit, his plans make me a little uneasy. Conceptually, I see the liquidity trap as something like a dam that could burst suddenly, though I could be wrong about that. And even if it did burst, the Fed would have all its old powers back. It could raise interest rates, and even bank reserve ratios if it came to that to control the inflation.
This is true enough, and it might even relate to Bernanke’s monetary policy. But it doesn’t relate at all to fiscal policy. The prescription for an economy like ours is crystal clear. We need a big honking stimulus package, and we need it right now. Unfortunately, our government is filled with incompetents, so we’ll just have to wait.
That sounds dangerously close to nonsense from the Hoover era. We do not need to “unwind”. We do not need “time”. Time is against us. And we don’t have a coming World War III to force us to do the right thing. We just need to remember our history, and our macroeconomics, and then pass the stimulus.
That might sound wasteful to you. It is not. The wasteful course of action is doing nothing.