Tuesday, November 15, 2011

The big question

Over at MR, Tyler pops it: "to what extent can a boost in nominal flow make up for a shortfall in wealth?"

The US economy suffered a severe real shock. Housing prices collapsed, equities fell. People discovered they were a lot poorer than they thought as 10s of trillions of wealth disappeared.

Individuals stopped spending and tried to start saving, cutting debt loads and re-building their balance sheets.

Meanwhile, our government has replaced the private debt binge with a public debt binge and "encouraged" saving by nailing interest rates to the floor.

These two moves are entirely incompatible with people's desires to rebuild their balance sheets.

Of course, the moves were undertaken to increase output and reduce unemployment. However, those results have been far short of overwhelming.

Many advocates of NGDP targeting argue that it works via an expectations channel. A rough version of the logic is, if real growth is low, the Fed will be creating inflation, which will erode the value of my money, so I better go spend it now!

I know I'm treading dangerously close to getting a Samuelsonian lecture on the paradox of thrift, but it's been three years now and the economy still stinks. I am not sure that this sad state of affairs is because we haven't punished savers enough.

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