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Source link: http://archive.mises.org/9836/take-advantage-of-the-liquidity-trap/

Take Advantage of the Liquidity Trap!

April 23, 2009 by

I was thinking about the Keynesian liquidity trap today, and I came to an interesting conclusion.

If Keynesian theory were true, and Krugman were right that we are in the liquidity trap, then the Fed has a rather obvious solution in its hands: print a bunch of money and pay off everyone’s debts. (It can do this by buying every loan, and then forgiving all of them.)

Immediately, the banks wouldn’t have to worry about toxic assets, as there would be none. Every debt instrument would be purchased at face value. Families wouldn’t have to worry about making loan payments, as the loans would be gone. Every single balance sheet in the US would show a large, positive net worth (well, except for those of silly renters – like my wife and me – who refuse to go deep into debt).

Now, the typical problem would be that such an action would lead to enormous price inflation.

But, not so right now! We’re in the liquidity trap! When we print all this money and hand it to creditors, they’ll sit on it so that it never gets spent, and never causes inflation. Keynesian theory is very clear on one point: you can’t print yourself out of the liquidity trap.

Just one more case where the logical conclusions of Keynesian theory demonstrate its absurdity.

{ 12 comments }

dewind April 23, 2009 at 1:13 pm

Indeed, the perfect recipe for redistributing the debt of everybody across the entire nation. So those that have a lot of debt are much better of. Those with little to no debt eat it.

You egalitarian you.

ShedPlant April 23, 2009 at 3:48 pm

The recent South Park episode does indeed suggest that if everyone’s debts were miraculously forgiven, prosperity would return ;) .

Sean W. Malone April 23, 2009 at 3:58 pm

I was thinking about that lately actually – and found it amusing to hear a number of groups suggesting that the government simply wipe the slate clean on various debts, especially student loan debt… It would be about the worst thing I could imagine for the future of the country as a whole, but my god I would personally clean up!

newson April 23, 2009 at 9:07 pm

free margaritas for all!

Michael April 24, 2009 at 6:34 am

Remember the Heinleinian adage: “There ain’t no such thing as a free lunch.”

Lars April 24, 2009 at 6:37 am

Here in Sweden, the debt to the Swedish state by individuals and private companies, are sometimes mysterieosly forgotten, I have come to know. Is this money given away? I have wondered. No, I have been told, this is not a gift. Then, this is all a mystery to me. The honoring of money as labor and natural resources, seems so be missing in this case.

David Spellman April 24, 2009 at 10:35 am

If you believe that hyper-inflation is imminent, then you should accumulate all the debt you can. Buy a house, buy a car, load up those credit cards. Then sit back and watch inflation pay off your debts. It actually works if you predict it right. Hyper-inflation makes debt go to zero.

I am planning to buy a house when the market bottoms out (real estate tends to follow the economy by about 2 quarters, so it can be predicted fairly well). Either I get a good deal and pay the mortgage like an ordinary person, or I get a good deal and get the house for free to boot. Sounds win-win to me.

Mike Brewer April 24, 2009 at 2:48 pm

I’m actually old enough (ouch) to remember the Carter years well.

I pretty much followed the David Spellman method outlined above.

It was our first house.

Inflation was at like 20%.

Interest rates were also high (I think like 12%) as Voelker had already started his heroic efforts.

Anyhow, that didn’t matter BECAUSE:
The interest rates went back down, but the dollar stayed down.

THUS: We re-financed at 7% with a teensy mortgage.

Aren’t we a bunch of evil scammers?

Danil April 24, 2009 at 5:15 pm

Errr. That’s not what the liquidity trap is, or at least not how I see the Austrian version. The point is that the Federal Reserve buys all these loans by printing magical cash and still demands repayment (a banker allowing the state to repay loans??? c’mon now). However the temptation for malinvestment is not acted upon by the general public, who intelligently begin to save. This desire to save prevents the malinvestment, preventing hyperinflation. Problem is that Americans have a great difficulty learning the lessons of their past, they’ll continue to let themselves be fooled once, twice, and even three times.However, this malinvestment is being placed with our money by the banks (esp. Goldman Sachs), when the market shocks to real values (as it will later this year). The outrage from this malinvestment will create the liquidity trap for several years (~8) until Americans quickly forget the lessons learned (helps when the truth isn’t spread word of mouth but by paid public officials – i.e. state-paid teachers). The only real question is who deep in debt does the Federal Reserve intend for us to get before it calls due America’s debt….

newsonn April 24, 2009 at 8:47 pm

david spellman, can you get a credit card with fixed interest rate? where i come from only variable rates apply, certainly not a winner in hyperinflation.

Lee April 25, 2009 at 10:26 am

Yeah, I had a similar idea.

You see, if the Dow Jones, S&P500, and NASDAQ indexes are based upon companies…

And companies report earnings in dollars, yen, gold plated latinum, ect…

And their stock prices directly correlate to their earnings… (Trust me, this is going somewhere)

We could bring the economy back to early 2008 if we just said “From now on… Every one dollar, is worth two dollars.”

BADDA BING! Now the Dow Jones is back to 14,000, and we haven’t done anything. Problem solved. We wouldn’t even have to print money, and the government wouldn’t have to pick winners and losers in the economy.

I think this plan is brilliant.

Ralph Musgrave January 3, 2010 at 4:03 pm

I think Keynes was aware of the sort of solution that Lucas E. advocates. All Keynes was saying that interest rates in some circumstances may have no effect. In this situation he said (as I understand it) that fiscal policy, i.e. having government borrow and spend more may be needed. However I can’t see the point of government borrowing. Simply printing money and dishing it out would be simpler and more effective.

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