Krugman: no reason economy had to suffer a large loss of output and employment

[Kurt_and_Hunter]

. . .

The other thought I have is that if our view of the current crisis as largely a deleveraging shock is correct, and if our basic outline of how things work in the aftermath is also correct — both of which I believe — then the gods really hate us. For the slump that follows a deleveraging shock is simultaneously gratuitous and almost impossible to avoid.

What do I mean by that? The model, and more broadly overall logic, suggests that there is good no reason why the economy has to suffer a large loss of output and employment after a Minsky moment. The capacity is there, and nothing about the fact that some people have too much debt makes it impossible to use that capacity to produce goods and services for other people.

But the policies that can prevent that gratuitous slump — a commitment to higher inflation over the medium term, and/or deficit spending — run right up against ingrained prejudices. The foundations for the shock were laid by a long period of relative stability, especially low inflation; it’s very hard for policy makers to accept that what was good in 2000 or even 2007 is no longer at all good now that Minsky has struck. And everyone has just seen the punishment for too much debt; asking others to run up debt to help fix the problem, even though it’s right, is unavoidably a tough sell.

We might nonetheless have been able to get through this with less damage if we’d had strong leadership and clear thinking from the economics profession. But as it was …

. . .

http://krugman.blogs.nytimes.com/2010/11/18/debt-deleveraging-and-the-liquidity-trap/

[dkf]

1. I don't understand how he thinks people waking up to the dangers of living on debt

Can be fixed by government inflating. I imagine if the government took over the spending that the output they buy would be different from that of the consumer.

[Kurt_and_Hunter]

2. The point is not that government would spend differently, but that it would spend at all

We reached a point where the private sector balance sheets got so bad that folks stopped borrowing and spending, and the economy goes down accordingly.

Because the economy is down folks cannot repair their balance sheets. Even if you stop borrowing and spending, without income your debts aren't going away.

An unemployed person with a lot of debt needs employment to even begin to tackle her situation, so it becomes a self-reinforcing cycle downward.

Somebody has to take up the slack to give the rest of the economy a chance to clear up their balance sheets and the federal government is the only player that can. Essentially the old phrase that the federal government can act as "borrower of last resort."

If the federal government does not pick up the slack with a lot of borrowing and spending short-term then the economy stays down and the underlying problems linger on.

[dkf]

3. Yes but he talks about capacity yet isn't the capacity in particular areas based on past patterns

Of consumption? If we stopped buying luxury goods for example who would take up that capacity? Not the government surely.

[Kurt_and_Hunter]

9. That's an interesting example

Luxury goods have held up better lately than most things because of the two-sidedness of debt.

Households have too much debt. That means that banks have "too much" assets. One man's debt is another man's asset.

And the financial sector is doing great, as is wall street. And luxury goods have held up better than other types of non-essential goods.

But because the shock is scary and we might fight deflation, the rich side holding all that paper isn't spending at the sort of rate they would have to balance the scales precisely because they are the investor class. They don't spend all their money up like most of us have to.

So in this kind of crisis there's a ratchet effect -- the rich snag the money and then hide it. They will invest it in productive job-creating things someday... when the economy picks up. But it won't because they are sitting on it.

Only the federal government can break that log-jam. Create good times by any means necessary and things start to happen, including the rich buying more luxury goods rather than hoarding against the threat of further bad times.

[dkf]

10. Yes but this goes to the argument that the segment that stopped buying is the segment

That needs to start rebuying as capacity is geared toward particular products. Yet when the population that was using that capacity were simply overextended these are not places the government can make up for.

[jpgray]

5. If government spending multiplies in its effect on GDP, what happens to gov't debt as % of GDP?

If inflation occurs, what happens to debtors and what happens to creditors?

[dkf]

7. Actualy the provision in the financial reform bill that disallows rate increases on earlier debt

Should protect consumers quite a bit if we do experience inflation and higher rates.

Over time inflation helps a mortgage become more affordable. But credit cards shouldn't be that long term.

[jpgray]

8. My point is that government debt is not much like individual debt

If I had a kitchen table for every time some pol said "the gov't needs to do what families are doing around their kitchen tables," I'd have quite a few.

[galileoreloaded]

4. Infinite expansion rhetoric=2010 "Manifest Destiny"

Your all hat and no cattle.....sorry Paul

[xchrom]

6. Recommend

[gratuitous]

11. Strong leadership and clear thinking from our MBA president?

Nope, the Republican agenda and plan was always to empty as much of the Treasury into the pockets of the wealthy as possible. And you all thought that "Mission Accomplished" banner was a reference to some military adventurism?