Yeah, well, I suppose I should admit don't buy the classic liquidity trap theory either. If you put a dollar into T-bills, you drive the interest rate a little lower, which causes, say, 70 cents of other investors' money to leave in disgust. Where do they go? To other assets.
And it's only 70 cents only because the suppliers of new debt, the US authorities, are sensitive to interest rates too. Investors can, net, only buy as much debt as the government is issuing, right? So if the Federal authorities are so worried about a liquidity trap, let them limit their debt issuance! If they do that, then your dollar put into Treasury securities means a dollar worth of other investors' leaving. No more liquidity trap. (At least as far as "highly-liquid and safe assets" == US govt debt. They could find other safe and liquid harbors, perhaps Japanese govt debt.) But the Feds aren't doing that, thus, I think that "having the government borrow at essentially zero cost and invest that money in public infrastructure projects" would in fact be bad for real wealth and prosperity because that borrowing brings some more money to T-bills and away from other investments, some of which would be private investments, for example. Of course if those projects are needed on their merits, not as make-work, then great, do them.
The same is true of your example of "parking cash in the bank". Parking cash in the bank means making investments. Where does the bank put it? They invest it. A bank is not a destination for money, it's a conduit.
This is why we have a new tech bubble: everyone is scrambling for somewhere to put their money, but none of them are willing to put it in the hands of consumers, which is the only place it will do any good.
This is why people are buying Treasuries like they're crack. Elasticity approaches zero when there is no substitute good.
I think I agree with you and am not sure where the disagreement is. Save possibly two points:
(1) Limiting debt issuance would only be expansionary if it didn't imply a reduction in government spending. And financing growth by expanding the money supply is a perfectly acceptable Keynesian solution. If this led to inflation and rising interest rates that would suggest the economy is no longer in a liquidity trap and the Fed could step in to rein in inflation while the government could go back to raising money on the bond markets.
(2) I'm under the impression that US banks reduced lending following the 2008 bailout. I seem to remember Andrew Ross Sorkin making this case, but either way - I don't think the best solution to the present crisis is a 20 year process of watching the banking sector delever as in Japan! Better to have controlled failures to wipe out debt and reduce moral hazard while making sure the economy is primed with the demand to deal with the fallout. How exactly to do that is a good question.
I mean I think there's no such thing as a liquidity trap, so I believe we disagree on that at least.
Regarding your point #2, yes I agree. But bailing banks out is exactly what Japan did. The certainty of regulatory capture by banks makes it better to just remove the government ability to bail them out. Let them fail. A moderate approach would be to limit bank mergers - too big to fail is too big.
Asserting that an economy is in a liquidity trap is equivalent to asserting that increasing the money supply will not drive up inflation or interest rates in the short term, but will drive employment and GDP growth.
I don't think it makes sense to argue that this situation is not theoretically possible since it appears to describe reality quite well. That said, the policy commitment that comes out of accepting even the possibility that we may be in a liquidity trap should be uncontroversial regardless of whether you believe the model is a close approximation of reality or not: push aggregate demand until there is some evidence it is driving up inflation and interest rates, at which point the theory says to stop because more of the same won't do any better.
Comments
Yeah, well, I suppose I should admit don't buy the classic liquidity trap theory either. If you put a dollar into T-bills, you drive the interest rate a little lower, which causes, say, 70 cents of other investors' money to leave in disgust. Where do they go? To other assets.
And it's only 70 cents only because the suppliers of new debt, the US authorities, are sensitive to interest rates too. Investors can, net, only buy as much debt as the government is issuing, right? So if the Federal authorities are so worried about a liquidity trap, let them limit their debt issuance! If they do that, then your dollar put into Treasury securities means a dollar worth of other investors' leaving. No more liquidity trap. (At least as far as "highly-liquid and safe assets" == US govt debt. They could find other safe and liquid harbors, perhaps Japanese govt debt.) But the Feds aren't doing that, thus, I think that "having the government borrow at essentially zero cost and invest that money in public infrastructure projects" would in fact be bad for real wealth and prosperity because that borrowing brings some more money to T-bills and away from other investments, some of which would be private investments, for example. Of course if those projects are needed on their merits, not as make-work, then great, do them.
The same is true of your example of "parking cash in the bank". Parking cash in the bank means making investments. Where does the bank put it? They invest it. A bank is not a destination for money, it's a conduit.
What other assets?
This is why we have a new tech bubble: everyone is scrambling for somewhere to put their money, but none of them are willing to put it in the hands of consumers, which is the only place it will do any good.
This is why people are buying Treasuries like they're crack. Elasticity approaches zero when there is no substitute good.
I think I agree with you and am not sure where the disagreement is. Save possibly two points:
(1) Limiting debt issuance would only be expansionary if it didn't imply a reduction in government spending. And financing growth by expanding the money supply is a perfectly acceptable Keynesian solution. If this led to inflation and rising interest rates that would suggest the economy is no longer in a liquidity trap and the Fed could step in to rein in inflation while the government could go back to raising money on the bond markets.
(2) I'm under the impression that US banks reduced lending following the 2008 bailout. I seem to remember Andrew Ross Sorkin making this case, but either way - I don't think the best solution to the present crisis is a 20 year process of watching the banking sector delever as in Japan! Better to have controlled failures to wipe out debt and reduce moral hazard while making sure the economy is primed with the demand to deal with the fallout. How exactly to do that is a good question.
I mean I think there's no such thing as a liquidity trap, so I believe we disagree on that at least.
Regarding your point #2, yes I agree. But bailing banks out is exactly what Japan did. The certainty of regulatory capture by banks makes it better to just remove the government ability to bail them out. Let them fail. A moderate approach would be to limit bank mergers - too big to fail is too big.
Asserting that an economy is in a liquidity trap is equivalent to asserting that increasing the money supply will not drive up inflation or interest rates in the short term, but will drive employment and GDP growth.
I don't think it makes sense to argue that this situation is not theoretically possible since it appears to describe reality quite well. That said, the policy commitment that comes out of accepting even the possibility that we may be in a liquidity trap should be uncontroversial regardless of whether you believe the model is a close approximation of reality or not: push aggregate demand until there is some evidence it is driving up inflation and interest rates, at which point the theory says to stop because more of the same won't do any better.
At today's interest rates a bank is a destination in the minds of depositors. It merely is holding value and preventing a loss in nominal terms.
Do you have evidence that people are leaving T-bills in disgust and investing in other assets?
Simply the fact that you can buy them in secondary markets.