"figures that suggest the need for a fiscal stimulus that’s enormous by historical standards": Were We In Our Old Universe

Paul Krugman on a Liquidity Trap:

"It’s a curious thing that even now, when we are clearly in a liquidity trap, we still have a lot of economists denying that such a thing is possible. The argument seems to go like this: creating inflation is easy — birds do it, bees do it, Zimbabwe does it. So it can’t really be a problem for competent countries like Japan or the United States.

This misses a key point that I and others tried to make for Japan in the 90s and are trying to make again now: creating inflation is easy if you’re an irresponsible country. It may not be easy at all if you aren’t."

One could ask the same question about the deficit and debt, but why bother?

"And once you realize that central banks may not be able to move expectations about future money supplies, it becomes a real possibility that the economy will be in a liquidity trap: if interest rates are near zero, money printed now just gets hoarded, and monetary policy has no traction on the real economy."

That's Japan. They're population is different than ours in their expectations and investing decisions, so that it's not obviously an apt comparison. For example, oddly, average Japanese investors are buying stocks now, while ours are shell-shocked.

"Back in 1998 I argued that the Bank of Japan needed to find a way to “credibly promise to be irresponsible.” That didn’t go down too well, but it was what sober, careful economic analysis prescribed.

Or as I said in the linked paper,

The whole subject of the liquidity trap has a sort of Alice-through-the-looking-glass quality. Virtues like saving, or a central bank known to be strongly committed to price stability, become vices; to get out of the trap a country must loosen its belt, persuade its citizens to forget about the future, and convince the private sector that the government and central bank aren’t as serious and austere as they seem. "

This sounds suspiciously like a policy of an elite fooling an ignorant public. Can't bother them with the truth. Isn't this the Paradox Of Thrift under a different guise? The answer is incentives.

"OK, so now back to Hatzius et al. They emphasize the role of the disruption of credit markets in pushing us into a liquidity trap. They then turn to an estimate of likely changes in the “private sector balance” — the difference between private sector saving and private sector investment. And it’s stunning:

The GS house price forecast combined with current equity prices and credit spreads implies a rise in the private sector balance from +1% of GDP in the second quarter of 2008 to +10% in the fourth quarter of 2009— - a rise of 9 percentage points, or 6 points at an annual rate.

What’s the answer? Huge fiscal stimulus, to fill the hole. More aggressive GSE lending. Maybe a “pre-commitment” by the Fed to keep rates low for an extended period — that’s a more genteel version of my “credibly promise to be irresponsible.” And maybe large-scale purchases of risky assets.

The main thing to realize is that for the time being we really are in an alternative universe, in which nothing would be more dangerous than an attempt by policy makers to play it safe."

Memo to Paul: We're still stuck here in the same old dustbin of a universe. This is a version of the Kitchen Sink Argument. If we are in a Lewis Carroll universe, mightn't the rules in it include printing money like it doesn't matter? And how would you judge that any more or less logical than an enormous stimulus and increase in the debt?

Funny thing about a Looking Glass Universe. It's devilishly hard to reason in.