We’re in a “Liquidity Trap”
December 18, 2011. Free-market economies have recession about every 4 to 8 years, and they usually last only about six months. Well that’s how they count it to be optimistic. That’s really just the time it takes to hit bottom, but after about 3 years thinks are usually headed strongly in the right direction.
Why not this time? Because the usual method of getting out of recession is broken. The usual method is for the Fed to lower interest rates. That makes it easier for people to buy house and for businesses to buy more office space, factories and equipment. All this is called investing. It’s also called demand-side stimulus. Economists call buying stuff “demand.”
The trouble is, the interest rate started out near zero and the Fed soon pushed it so close to zero you can’t tell the difference, but that wasn’t enough. That’s because interest rates started lower and this recession is bigger than usual.
The way the Fed reduces interest rates is to make more money available—economists call that more “liquidity.” But interest rates can’t go below zero because it makes no sense to pay someone to borrow your money. So the zero limit on interest rates is the trap. Hence, the “liquidity trap.”
What to Do?
December 18, 2011. There are two basic ways to increase demand: (1) Monetary policy, and (2) Fiscal policy. Monetary policy means the Fed increases the money supply, and fiscal policy means the government buys things or cuts taxes to get us to buy things. Back in the 1960’s and 70’s there was a huge debate between conservative economists, like Milton Friedman, who said to use Monetary policy for recessions and liberal economist, who said to use fiscal policy. Fiscal policy is also called Keynesian policy because Keynes developed the theory for why it is sometimes needed.
Regarding normal recessions, Monetary policy is quicker and cheaper than fiscal policy. But by the time Obama took office, the economy was already in a liquidity trap and Monetary policy could do very little. So a month after talking office, Obama passed the stimulus bill—that’s fiscal policy, and it worked. But it was too small, and due to Congressional nonsense it was not well designed. Still, as you can see, it hastened the recovery, and according the Congressional Budget Office, it add a couple of million jobs.
Unfortunately, as the stimulus ran out, jobs were cut. This is anti-stimulus and that began, far too soon, near the end of 2010. Anti-stimulus should not occur until the economy is growing rapidly, and can absorb workers laid off as the stimulus ends.