By Doug Gentry, on December 30th, 2011
Was it Popeye’s friend, Wimpy, who kept asking for a hamburger on credit? Today’s credit markets are anything but robust, with reduced demand and supply for borrowed funds. Always eager to find obscure terms for modern dilemmas, economists refer to this condition as a liquidity trap. With a little prodding from Facebook friend and neighbor, Patrick, we’ll give the concept a once over.
Jumping to the conclusion (and resisting the academic approach of a slow, careful warm-up) there is bad news and good news about liquidity traps. The bad news is that they make it difficult for the Federal Reserve to execute monetary policy. Creating 100s of billions of dollars has a muted impact on our economic recovery. The good news is that the liquidity trap dampens the significant inflation we might expect with the creation of all that money.
OK, back to the beginning. During times of slow or no growth and high unemployment the Federal Reserve can create/inject money, largely by increasing reserves that banks have in their accounts with the Fed. They can do this by buying U.S. treasury bonds on the open market, or even by buying troubled/toxic assets from banks. This increase in the supply of money allows interest rates to fall, which in term spurs demand for more consumption and investment. This is classic monetary policy. With mild downturns this is often enough to increase growth and kick start the economy. For the most recent 2007-2009 recession the Fed took these actions, a number of times in a number of ways, and those actions were not sufficient. Now the target short term interest rate – the Fed Funds rate – is essentially at zero. The Fed can’t lower the interest rates any further. Here’s a graph of the Fed Funds rate since 1980. The big peak at the beginning of the graph was the result of aggressive Fed action to contain inflation. Now, though, the rate has sunk to the very floor.
 Fed Funds Rate – St. Louis FRED database One thing that is happening is that while reserves are building up in our financial system, the banks are holding on to them rather than increasing their lending. Some argue that the banks are using the added funds to improve their balance sheets, which were hurt by the dramatic loss in value of securitized mortgages and other derivative assets, and to build up enough cash to pay executive bonuses. The banks argue that demand for credit by qualified borrowers is low. I don’t put much credence in the latter explanation. One apt analogy for this situation is that the Fed is trying to push on the end of a string, in order to get the economy going.
There is another layer to the liquidity trap concept, and that has to do with the buying public’s (people and business) expectation for inflation. The theory goes that if buyers expect inflation in the future, they will increase buying now. They expect the value of their cash or savings to go down during inflationary times, so they seek to use it now, while its value is still high. This works with traditional monetary policy where an injection of money would be expected to increase inflationary pressures.
On the other hand if purchasers believe that inflation will be controlled, then there is less pressure to buy now. That’s what is happening now. Despite what some politicians suggest, inflation is not right around the corner, and buyers are in no hurry to convert their cash into goods. We see evidence of this with the continuing low interest rates on U.S. bonds. Expectations of high inflation would push those interest rates up. Low inflation expectations, even in the face of increasing money supply is another symptom of a liquidity trap.
This scenario played out, to grim effect, in Japan in the 1990s, as their central bank poured money into the banking system and no one responded. Their “lost decade” was one of almost zero growth.
This paper by a New York Federal Reserve staff economist explains things in more detail, complete with impenetrable equations.
By Doug Gentry, on April 29th, 2011
Freidrich Hayek and the Austrian school of economic policy argue for a laissez faire approach to the economy – emphasizing individual actions and criticizing government intervention. John Maynard Keynes acknowledged that economies could, over time, correct themselves, but argued that government had a responsibility to intervene and stimulate demand when the economy is in a slump. This video is a sequel to Fear the Boom and Bust, also produced by Econstories.tv
For my students, see how many of today’s economic issues you can find in this video and compare them to our look at the Great Depression.
By Eldon Mast, on October 4th, 2010
Late last month, President Barack Obama signed legislation that will cut taxes and provide credit help for small businesses. It is yet another step that the government is taking to continue programs that spur job growth in the U.S. economy.
The Small Business Jobs Act is now the fourth jobs measure that Congress has enacted this year — it is likely to be the last before the Nov. 2 midterm congressional elections.
The bill provides billions of dollars worth of tax cuts over the next 12 months, with the bulk coming through “bonus depreciation.” The measure allows companies to more quickly write off the cost of business-related purchases. The bill also revives stimulus provisions that cut fees and increase limits on loan guarantees offered by the government’s Small Business Administration.
By Bron Suchecki, on July 20th, 2009
Continuing the theme of my recent posts. This from Troy Schwensen at The Global Speculator:
Australia’s Prime Minister, Kevin Rudd, has recently delivered an address to the nation providing details on his second stimulus package. Within this briefing, there was a number of sniping remarks about the so called “failure of free markets”. This apparent failure has forced the government to step in and clean up the mess. … It seems free markets cannot be trusted to spend money wisely, so it is up to the government to spend our money for us. I want to make a couple of points.
Firstly, free markets work fine. The global problems we have experienced in the credit markets were caused by easy monetary policy. Many argue the cause was a lack of financial sector regulation. The more pertinent question to ask is why does the financial sector need so much regulation in the first place? Why is it that free markets work well in other industries but fail so dismally when it comes to the financial sector? The answer is quite simple. The financial markets are anything but free! We have a government entity called a central bank that essentially sets the price of money. It decides the level of interest rates under the flawed belief that the market is incapable of performing this function on its own. …
The second point I want to make is governments are incapable of investing money smarter than individuals and companies. By deficit spending, they are drawing funds away from the capital markets and effectively competing with businesses for money. Over the longer term, this will put upward pressure on interest rates exacerbating our economic problems. What Australians should be doing right now is saving and paying down debt. At some point this will inevitably have to happen anyway. By lowering interest rates to historically low levels, the message central banks are sending is don’t save, borrow and spend. Governments are releasing stimulus packages encouraging us to spend and “save the economy”. You cannot save an economy via consumption. All you are doing is prolonging the agony. Individuals and organizations need to clean up their balance sheets and save.
By Eldon Mast, on June 24th, 2009
The G-8 is composed of the U.S., Japan, Germany, France, U.K., Canada, Italy and Russia. Representatives met over the weekend in Lecce, Italy to begin crafting an agenda for when a broader set of leaders meet on July 8-10.
The group acknowledged that they are now considering how to back out the swift rescue actions taken last year because the world economies are beginning to show signs of recovery.
“We discussed the need to prepare appropriate strategies for unwinding the extraordinary policy measures taken to respond to the crisis once the recovery is assured,” the leaders asserted in a collaborative statement. “There are signs of stabilization.”
“Early signs of improvement are encouraging, but the global economy is still operating well below potential and we still face acute challenges.” said U.S. Treasury Secretary Timothy Geithner.
“There is a distinct shift in tone from the G-8″ during this meeting, said Eswar Prasad, of the Brookings Institute.
“There are increased signs of stabilization in our economies,” the G-8 re-emphasized. The group renewed their commitments to take “all necessary steps to put the global economy on a strong, stable and sustainable growth path.”
By Trace Mayer, on March 25th, 2009
C.S. Lewis’ short but masterful The Great Divorce is about Ghosts in Hell who journey by omnibus up through a crack in the earth to meet Solid People and hopefully be guided into the mountains. As the Ghosts become substantive their feet are pricked by the sharp grass. Only a few overcome their problems and journey into the mountains while most board the bus and shrink into oblivion as it descends back down the crack from whence it came.
In the financial realm, many are lured by the the derivative illusion and ensconced in a rapidly dissipating cocoon of self-satisfied self-deception woven over their eyes and mind leading to their faulty thinking that the way they see things is the way things really are. Fractional reserve banks and fiat currency have wrecked predictible havoc and mayhem on the entire world economy. Fortunately, monetary and currency alternatives exist.
HOW TO INTENTIONALLY CAUSE THE GREATER DEPRESSION
The Great Credit Contraction and the accompanying liquidation of malinvestment is to be embraced and not feared. As Murray Rothbard observed on page 18 of his 1963 America’s Great Depression, “It is true that credit contraction may overcompensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market. But since contraction causes no positive malinvestments, it will not lead to any painful period of depression and adjustment.”
Mr. Rothbard continues the observation that government policy can hobble the adjustment process by: “(1) Prevent or delay liquidation, (2) Inflate further, (3) Keep wage rates up, (4) Keep prices up, (5) Stimulate consumption and discourage saving and (6) Subsidize unemployment.”
In the present case, mark-to-market rules, like FAS 157, are not implemented, delayed, ignored or willfully violated. For example, Section 132 of the Emergency Economic Stabilization Act of 2008 is titled “Authority to Suspend Mark-To-Market Accounting” and restates the SEC’s authority to suspend the application of FAS 157.
The Austrian definition of inflation is an increase in the money supply. The Adjusted Monetary Base, the very lowest layer of power money, shows a tremendous increase over the past couple months. The effects are most likely masked by the tremendous slowing in the velocity of money.
In an effort to stimulate consumption and discourage savings that will result in keeping prices and wages high the Obama administration has unveiled a $1 trillion stimulus package. The Geithner toxic asset plan will only serve to hasten the destruction of wealth from the economy as the system evaporates.
Minimum wage is set to rise for the third consecutive July. Unemployment will be subsidized by extending benefits for 13 weeks and delaying the income tax payments. Legacy industries, like the auto industry, are receiving bailout money to keep wage rates up and people employed doing nothing all day long because of the huge over capacity of automobiles.
Austan Goolsbee, a senior Obama economic adviser, said on CBS’ Meet the Press, “We’re out with the dithering, we’re in with a bang.”
FINANCIAL INSANITY VIRUS EPIDEMIC OUT OF CONTROL
Well, it is obvious that the Financial Insanity Virus epidemic is raging on Wall Street and in Washington. They are hitting the bulls-eyes on all six policies to hobble any potential recovery. The result will be a lengthening and intensifying of The Great Credit Contraction and resulting Greater Depression. Worse is that these criminal gangs costumed in government regalia have no excuse for not knowing what the result will be. Therefore, they are acting either with premeditation and deliberation or with reckless disregard for the world economy and all the individuals affected.
This will result in a lot of economic and physical pain and misery coupled with individual culpability. As the mentor in The Great Divorce sagely taught, “All who are in Hell choose it. Without that self choice there could be no Hell.” Indeed, “to be afraid of oneself is the last horror.”
“All Hell is smaller than one pebble of your earthly world: but it is smaller than one atom of this world, the Real World.” The Great Credit Contraction continues to grind while the illusions evaporate making many organizations and institutions increasingly irrelevant. Hopefully these soon to be worthless entities that are gluttonous parasites on the global economy will become at the most footnotes in the annals of history.
By Dan McLaughlin, on March 6th, 2009
“The Audacity of Hope” is a catchy phrase with important implications. It is good to hope, to look forward boldly in anticipation of better times, to have a positive outlook that is open to opportunity. But, just as it is not a good idea to run around in the dark with a sharp butcher knife, it is also not a good idea to boldly pursue policies with blinders on, while wielding dangerous economic weapons.
The “war on poverty” has been a miserable failure, in spite of the trillions of taxpayer dollars spent over the last 4 decades. The “war on drugs” is another expensive failure on all fronts. Central planning in American education has resulted in a very expensive system that is failing our children. Ask any supporter of the welfare state, however, and the ongoing failures of government programs result only from not throwing enough money at them. It doesn’t matter what miserable results from whichever government program, the only proposed solution to the problems is more money stolen from taxpayers.
In the real world, if a private business or association is not successful, it either changes the way it does business and serves people or it takes a one way trip to the business graveyard. Bankruptcy and failure ensure that bad ideas or inefficient, unproductive systems don’t keep sapping life from the productive sectors of society. That is the way that society progresses and economies advance.
Not so with government. It seems that the bigger the failure, the more support it gets. We have been victims of expensive stimulus plans for some time now. Remember the cure-all about a year ago? If only the wise politicians could take enough money from taxpayers to redistribute to taxpayers, they could jump-start the economy. Not enough. More billions prop up banks and failing businesses. Between the Federal Reserve Bank, FDIC and the multiple stimulus spending plans, the toll is now in the multiple trillions of dollars.
With all of the smart people purportedly hanging out in Washington DC, you would think that they might realize that, if you take a dollar from Joe and give it to Frank, and a dollar from Frank and give it to Joe, you really haven’t stimulated either. Worse yet, if you take a two dollars from Frank, give one to Joe and keep one to feed the beast, you have actually de-stimulated and made the whole economy less productive.
Stimulation is the fundamental reason that this country and the world are in their present sad state of affairs. Central banks try to stimulate economic performance at the beginning of an economic boom by pumping counterfeit money into the economy and lowering interest rates below the market rates. That stimulation only distorts the real economic incentives. The inflation devalues the dollar and creates bubble economies, where certain sectors inflate at a quick pace, giving the illusion of rapid real growth. In the present case, artificially low interest, specific homeowner incentives, government subsidized mortgages and ownership programs, and requirements for banks to offer loans to risky borrowers combined for the deadly combination that exploded into the current meltdown.
Those same smart people in our nation’s capital choose to ignore the obvious, and instead, throw trillions of dollars of good money after bad. Instead of fixing the core problem, they play political games for fun and profit. It is hard to believe that hundreds of the most well connected and powerful people in the country can be so willfully ignorant. That is, hopefully, the case, however, because if it isn’t, it means that, instead, they are willfully malicious. They consciously hurt the people they pretend to help.
Audacity, in the positive sense, means boldness or daring. It is a characteristic of effective leaders.
There is, on the other hand, an old saw among seasoned airplane pilots: “There are old pilots and there are bold pilots, but there are no old bold pilots.” Audacity is sometimes the precursor to disaster, because it substitutes cockiness for clear thinking, and throws caution to the wind. In this time of crisis, our leaders have thrown caution to the wind. They are flailing in the dark so they can say they are doing something. They are prescribing poison as the antidote for poison. They don’t think about the ramifications and, instead, rely on knee jerk reactions, which will ultimately multiply the problems they themselves have created.
Wouldn’t it be refreshing if our politicians would have the audacity to actually think for a change?
By Moyo Mamora, on February 26th, 2009
The American Recovery and Reinvestment Act, commonly known as “the Obama stimulus plan” or “bailout plan” got signed into law recently, after weeks of haggling in the House. The stimulus plan has a total price tag of $787 billion, and represents 5.5% of gross domestic product (GDP), although its impact on the economy may be less and will be spread over several years.
The bill can be categorized into 3 major parts with a common goal of stimulating the economy:
1. Direct payments to individuals
2. Federal tax cuts
3. Purchases of goods and services
Outlining some parts of the bill as follows,
Direct payments to individuals:
- $41 billion to extend through December, 2009, the extended unemployment benefits program that was scheduled to begin phase-out in March; increases jobless benefits by $25 per week; includes a temporary suspension of taxation of certain unemployment benefits
- $14 billion in special one-time payments to recipients of Social Security, SSI, and disabled veterans
Reductions in federal taxes
Individuals:
- $116 billion for a refundable tax credit of up to $400 per worker ($800 filing jointly), phasing out beginning at $75,000 of income ($150,000 for joint filers)
- $15 billion expansion of the Child Tax Credit
- $70 billion for a one-year extension of the Alternative Minimum Tax patch
- $14 billion partially refundable $2,500 higher education tax credit
- $6.6 billion for an enhanced tax credit of $8,000 for first-time home buyers
- $5 billion for extended bonus depreciation and increased small business expensing for capital expenditures in 2009
- $20 billion in tax incentives for renewable energy and energy efficiency, including cost of renewable energy facilities, energy efficient home upgrades, purchase of plug-in hybrid vehicles
State and local governments:
- $22 billion for new bond program for school construction, rehabilitation and repair, and private activity purposes
Purchase of goods and services:
- $87 billion in matching Medicaid payments
- $30 billion for power grid improvements, advanced battery technology, and state and local government energy efficiency improvements
- $15 billion for scientific research
- $7 billion for broadband services to underserved areas
- $19 billion for improvements to healthcare information technology
- $25 billion Cobra subsidy for nine months
- $54 billion State Fiscal Stabilization Fund for schools and public safety
- $13 billion for Title I education grants
- $12.2 billion for IDEA education grants
- $29 billion for road and bridge construction
- $16.4 billion for mass transit
- $18 billion for clean water and flood control
So what can one say about this? When life was good in the American economy people generally spent money without thinking too much about it, pretty much spending money that was not really theirs to satisfy cravings that could have been subdued by discipline. Then a brief slowdown in the economy gave rise to the credit crunch, and then folks began to realize that money can’t be spent on every whim, because it wasn’t as freely available as it was. Now this plan suggests that the broke US government in debt to the tune of about $12 trillion wants to add another $1 trillion in debt to its books, with the hope that spending this “non existent” money, will help revive the economy. In other words let’s do what we did to get us in this mess to get us, only we’ll do it on a much larger scale. This thought process embraces the idea that if it was not really worth it before because it was stupendously expensive in the boom years, it is absolutely necessary in the contraction years, and we need to keep the price high still. Like everything that goes in simple into the House, it comes out much more complex and filled with pork, the bailout plan went in at approximately $700 billion, and came out closer to $1 trillion.
Going back to some basics in fiscal policy, the government can only raise money by:
1. Taxing it
2. Printing it
Now because the government is not a “for profit” organization and merely a regulatory one, ideally it has no business interfering in markets. However Keynesian economist believes that in times of economic contraction, the government ought to spend its way out of the contraction. Everything we see around today are evident of Keynesian economist in Washington. Are they wrong? I don’t know, but they do have a lot of excesses that don’t make sense in my basic understanding of free market capitalism.
With all that said, back to the issue, so this Act proposes to cut taxes and print more money, the first will create further deficit (make the broke government more broke) and the second will cause mega inflation (except you believe the government will print just enough money that the economy needs to be “stimulated”).
So the point of this Act is to facilitate spending, and get people back in jobs, which makes sense, but do the benefits outweigh the cost? I don’t think so. I believe these economists are acting like the economy should grow forever. The economy had grown malignantly in the past couple of years in a period of extreme prosperity and people developed bad habits, these habits are what the current recession is supposed to change, as well as clear all blocked atteries in the heart of the economy. Shouldn’t America allow the process of creative destruction to take place, given that America prides itself in her free markets? There have been extreme excesses in the economy that require an extreme contraction to clean up, should the big three really collect bailout money when they make CRAPPY cars? Should banks really get bailout money when they made UTTERLY STUPID investment decisions? Should consumers be given bailout for BAD CHOICES? Should pornographers be given bailout money because people are beginning to realize that they don’t need porn but their wives?
The system should clean itself up, and the government should do what it takes to make the process not as painful as it should be, but I don’t believe government should act like there’s something that can’t fail. Heck the system failed, why is that so hard to accept!
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