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.