The Federal Reserve has not actually stumbled into either a Keynesian or Krugman-type liquidity trap. The Federal Reserve has actually created an “inflation trap,” whereby today’s low interest rates have set us on a course of a future inflationary credit boom, which will be followed by either higher interest rates or hyperinflation and a subsequent crisis. Fortunately, banks have not unleashed the massive amount of reserves that now exist in the banking system. FULL ARTICLE
Source link: http://archive.mises.org/9142/liquidity-traps-versus-inflation-traps/
Liquidity Traps versus Inflation Traps
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surely the 30 year bond contract has to be about the most spectacular short-sell available. a speculative blow-off in a 27-year bull market.
merry christmas all!
“On the contrary, falling prices will increase purchasing power of money and restore prosperity. By this reasoning, an increase in the money supply will also increase purchasing power of money and restore prosperity.”
Should it not be “a decrease in the money supply” instead of “an increase in the money supply”? Maybe I got it wrong, but I always assumed that an increase in the money supply with respect to an absence of change in the quantity of goods and services causes a decrease in the purchasing power of money.
Pat,
I stumbled over that paragraph, too.
The author was referring to the idea of sticky prices, so it would read like:
“If prices truly were ‘sticky’, then an increase in the money supply will also increase purchasing power…”
The author goes on to refute that theory.
This seems to be a parallel argument to Prof. Antal Fekete’s recent discussions on gold backwardation. Does anyone else see the similarities?
From:
http://financialsense.com/editorials/fekete/2008/1222.html
Quote: “One can achieve 0.25% annualized by carrying gold for 190 days till June 26, 2009. 190 days in maturity is about equivalent to a 6-month T-bill with a current yield of 0.18%. The cost of carry for 190 days is 0.25 – 0.18 = 0.07%. If we compare this with the cost of carry for 11 days till December 27, 2008, and, again, for 69 days till February 27, 2009, [calculation included, not reproduced here], then we get that the cost of carrying gold is as follows (all percentages are annualized)
for 11 days: 1.005%
for 69 days: 0.9%
for 190 days: 0.07%
That is pathological without any need of further explanation! It costs more to carry gold for shorter periods of time than for a longer period – according to the futures market.”
Am I interpreting this correct?
So basically you are making the case that interest rates that move upward would encourage the banks to lend more?
Thanks Mikebrah. I didn’t realize the author was referring to the idea of sticky prices.
This is a little off topic, but with all of this reserve money apparently sitting around, what would be the impact on inflation if instead of trying to get banks to lend (which apparently isn’t working), the Fed suddenly decided all banks needed 100% reserves from now on? If they aren’t lending it anyway, why not just make them keep it as reserve for all their on demand deposits?
Isn’t part of the problem that wages are sticky? Prices in general may not be, but if wages are – because of minimum wage laws and the refusal of unions and policy makers to let wages decline – then this creates the likelihood of serious unemployment, which the Fed must attempt to combat, by fighting deflation in the rest of the economy. To be clearer, what I’m saying is that since the government won’t let wages adjust to the deflationary forces, they must stop the deflationary forces from gaining momentum. This seems to be the dynamic at work.
I have a couple points on this:
“A final problem with Professor Krugman’s assessment of our current situation is that he has ignored an important recent change in Federal Reserve policy. As of October 9, the Federal Reserve began paying interest on excess and required reserves.”
“Why should US banks go to the bother of loaning out all of their increased reserves to gain interest if the Federal Reserve is already paying them interest on their reserves?”
The paying of interest on reserves is a way for the Fed to make permanent the injection of money. The interest amount would equal the annual increase they think is required to maintain stable prices. This is Chicago school price stabilization. It formalizes the process.
The reason banks would lend the reserves is the riciprocal of the reserve requirement of 10%. They can lend up to 10 times the reserve amount. A good read in this is Jesus Huerta de Soto, Money, Bank Credit, and Economic Cycles, chap 4, The Credit Expansion Process, pg 245
What the Fed can’t do at this point is force the banks to loan money. Unless the banks loan money, the inflation that the Fed desires won’t happen. How can they force them to loan? One way is for the government to buy shares in the banks. Oh, they did that? It is only a matter of time before control of the bank by its new stakeholders forces the loan issue.
See todays Wall Street Journal and get to opinion page to the letters to editor and read what an 81 year old has to say about the FRBord JFG
Do we really need to refer to Krugman as a Nobel Laureate? He received his prize for insulting the bush administration and hasn’t contributed anything to economic thought for quite some years. Just gives him a bigger soapbox to tell politicians its best to borrow and spend.
I consider the nobel prize to be a certificate of compliance with marxist thought in one’s chosen field of study anyway.
If monetary inflation by the Fed and fiscal payoffs/bailouts by congress and the administration are not sufficient to turn things around, there remains one more major “stimulus” weapon in a Keynesian’s bag of tricks. In a New York Times op-ed article (“Franklin Delano Obama, 11/10/09) Krugman–urging Obama not to be faint in spending OPM (viz. other people’s moeny)–went so far as to criticized his hero, FDR, for not sticking to his Keynesian guns, so to speak, during the Great Depression. Krugman wrote, “FDR wasn’t just reluctant to pursue an all-out fiscal expansion–he was eager to return to conservative budget principles. That eagerness almost destroyed his legacy. After winning a smashing election victory in 1936, the Roosevelt administration cut spending and raised taxes, precipitating an economic relapse that drove the unemployment rate back into double digits and led to a major defeat in the 1938 midterm elections. What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.”
For Keynesians, war is not an economic and human catastrophe. It is a public-works project and thus a fiscal stimulus adequate to a distressed economy’s needs. Maybe those Nobel guys will add a Nobel Peace Prize to Krugman’s honors, which he can share with another Keynesian, Yassar Arafat.
This really is a scene out of Titanic. It really does sounds as if everyone is trying to straighten up the deck chairs while the boat is listing badly. Does it really matter what Klugman thinks? Soon whatever Klugman has said will be passe’ as the ship goes further under the water dragging down the Fed with it. Any discussion regarding the merits of Fed decisions or Klugman theory or Keynesian blathering on fiat currencies will soon be of academic interest only. Assuming there will be academics left in their state supported ivory towers.
Only Fekete knows what’s happening. Only Fekete say’s we have to open the mint to the peoples gold now. Only Fekete is calling on the unions to take to the streets to bring down the Fed. Only Fekete explains what caused a thousand years of Dark Ages and why it will be coming back if the mints are not opened soon. Only Fekete champions Adam Smiths Real Bills Doctrine showing that banks are not needed to finance most commerce. Only Fekete say’s its not a dollar crisis but a gold crisis.
The US dollar is dead. All the world’s fiat currencies are dead men walking. Gold is going into hiding. Try and buy a single kilo of silver bullion. Its already gone. Soon gold will follow.
http://www.professorfekete.com/articles%5CAEFLaborLeaders.pdf
Keith,
Regarding the implementation of 100% reserves, Lucas Engelhardt beat you to it.
http://blog.mises.org/archives/009068.asp
bernard palmer:
“Only Fekete champions Adam Smiths Real Bills Doctrine showing that banks are not needed to finance most commerce. Only Fekete say’s its not a dollar crisis but a gold crisis.”
rbd = monetary crankism. refer to the mike sproul vs. mises debates on the blogs.
a gold crisis? how could this possibly be squared with the overwhelming demand for the metal? another case of “not making sense”.
Good article. Artificially keeping interest rates too low is a recipe for disaster long term (a lesson we should already have learnt). Unfortunately, politicians and, apparently, Ben Bernanke, are only interested in the short term. They want us to feel that they are doing everthing possible to help us when all they are doing is prolonging the agony – agony that they helped to create by keeping interest rates too low for too long!
As a layman with some interest in these econmic issues, I wish the author had given a better explanation of the theory he’s refuting. Perhaps I need to read krugman’s recent book. Ugh.
Hyperinflation is always great fear because work/job is rendered of less value with paycheck worth less. Better short-term downturn than dollar earned being worth a dime. Undercuts work ethic too. If hyperinflation hits, what is remedy?
One solution about referring in a less “respectful” way to “Kriegmann” (Warmonger) would be to always state that his “Nobel” prize is a “Central Banking Nobel Award”…
Still, former “freedom” Nobel prize also include Mr Kouchner. He is about the only French politician who favored military intervention in Irak… and later, as a Foreign Affair Ministry, also in Iran…
In essence, the Fed is paying banks to make loans. With an upcoming stimulus package likely to eclipse $1 trillion, lending will begin to increase. Yet the position of the Federal Funds Rate gives “Helicopter Ben” plenty of ammo to fight future inflationary problems.
Remember, Keynesian’s believe inflation to be rising prices. Austrians on the other hand believe inflation to be increasing the quantitative supply of currency. As the reality of the situations proves, inflation is coupled with falling prices. The Austrian view in this regard is correct, while also providing a more intimate view of monetary theory. Rising prices are only a SYMPTOM of inflation. Talk to any Keynesian and they will tell you we are not in an inflationary predicament, yet reserves are in excess eclipsing 100%.
Japan’s experiment with quantitative easing was unsuccessful because of two problems. The first was that they lack a retirement system, which causes them to save via their postal savings system. Also, Japan has a negative population growth rate which creates the risk of Keynesian textbook definition of recession naturally. Couple this with the fact that stimulus did not induce consumption, and it is easy to see why it was such a failure.
The US on the other hand has an increasing population, ultra high consumption (a negative savings rate ie: trading real wealth for consumption purpose), and social security. I have very little doubt that a multiplier effect will shore up their desired recessionary gap.
Regarding my comment about the low FFR, price increases can be controlled due to an unprecedented target. As prices continue to rise,
100% increases in the FFR will begin to starve off instances of demand pull (theoretically). Again, I am not worried about their ability to be successful.
What I am worried about is the future creation of asset bubbles. Can Obama’s team push money into renewable energy, and conservation? More importantly, why are businesses so concerned with short run profitability, when long run demand will be in renewable’s and technical innovation?
Great article and great advice Dr. MacKenzie.
The fact that Krugman makes these explanation via quantity theory and time preference theories (something Keynes totally rejected) further suggests that Krugman has no clue what he is talking about.
Rather, Krugman is using Keynes’ name to push an erroneous idea that is indeed his own rather than that of “the Cambridge King of Inflation “.
The liquidity trap Keynes refers to has absolutley no application in todays modern money economy.
His model refers to an exogenous money supply and an endogenous interest rate.
In a modern monetary economy interest rates are set exogenously and the money supply is endogenously determined by the banking sector.
Other problems arise due to governments / Central banks being monoplist suppliers of high powered money (country dependent obviously).
Taxes being only payable using the very same high powered money by which the government / central bankis the monopolist supplier.
Then there is the propostion that all government spending occurs via money creation – for which alternative propositions are fanciful at best.
By the time we get to bonds one side assumes they are used to fund deficit spending another side will swear till they are blue in the face that binds are simply an interest rate maintenace tool (selling or buying bonds decreases or increases the excess reserves held by banks at the central bank — from which the target rate is determined……
The FED need to raise the white flag and just admit they do not know what they are doing.
Good article. Artificially keeping interest rates too low is a recipe for disaster long term (a lesson we should already have learnt). Unfortunately, politicians and, apparently, Ben Bernanke, are only interested in the short term. They want us to feel that they are doing everthing possible to help us when all they are doing is prolonging the agony – agony that they helped to create by keeping interest rates too low for too long!
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