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You could either have a federal investment arm to create demand in times of need.

Did you know that the European Investment Bank has a stack of projects ready to fund in Greece, but it cannot fund them because half of the funding needs to come from the member state concerned and austerity policies don't allow Greece to spend any money on such projects?

A strong currency protects the purchasing power of consumers, making vital imports like gasoline, coffee, bananas (and foreign vacations!) cheaper

The EU has balanced external trade. Do you think monetizing sovereign Eurozone debt would change that?

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2012 at 05:53:21 PM EST
[ Parent ]

Yes. And you can't blame me for those stupid rules. :)
I don't see your point. The EU as a whole needs imports, and the stronger the currency, the cheaper they'll be. And trying to repair weak competitiveness with devaluations might work once, but it's hardly a long-term fix. See Sweden in the 70's and 80's.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Sat Mar 17th, 2012 at 06:29:34 PM EST
[ Parent ]

My point re:2 is that we wouldn't be in a crisis without the wrong, irrational belief that monetizing sovereign debt weakens the currency and/or creates inflation.

After all, apparently, monetizing toilet paper created by the shadow banking system does nothing of the sort.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sat Mar 17th, 2012 at 06:50:47 PM EST
[ Parent ]

Look, I'm not saying monetizing debt would create inflation either - not as long as we're stuck in the liquidity trap.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Sat Mar 17th, 2012 at 06:57:04 PM EST
[ Parent ]

What is a liquidity trap?

by kjr63 on Sun Mar 18th, 2012 at 01:05:25 PM EST
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Re: solidarity (4.00 / 3)

Its when everybody (people, corporations, banks) hoards cash, because they think there will be tough times ahead. Nobody invests, and presto, tough times it is.

A vote for PES is a vote for EPP! A vote for EPP is a vote for PES! Support the coalition, vote EPP-PES in 2009!

by A swedish kind of death on Sun Mar 18th, 2012 at 01:16:09 PM EST
[ Parent ]

From Wikipedia: "A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels."

In short, as interest rates are already zero, they can't be cut any further. Hence something else is needed to stimulate the economy, like infrastructure spending or quantitative easing (and the efficacy of the latter is somewhat questionable in my opinion).

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Sun Mar 18th, 2012 at 01:49:25 PM EST
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Jake's explanation is interesting, but there's the Wikipedia:

From Wikipedia: "A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence to stimulate economic growth.

Private sector is loaned up. No more (credible) debt takers.

A liquidity trap is caused when people hoard cash because they expect..

The confidence fairy?

..an adverse event such as deflation,

Rotschilds were very handy creating deflation (according to the movie "Money Masters").

by kjr63 on Sun Mar 18th, 2012 at 02:18:11 PM EST
[ Parent ]

From Wikipedia: "A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence to stimulate economic growth.

This actually suggests that we don't have a liquidity trap. Central bank has lowered interest rates. Mortgages are cheaper than ever. They just can't go below zero.

Also this suggests that lower interest rate to private sector necessary stimulates economic growth. It does not, if the private sector is over-indebted already.

by kjr63 on Sun Mar 18th, 2012 at 02:44:41 PM EST
[ Parent ]

We're at the zero lower bound.

See Paradox of Thrift

Two caveats are added to this criticism. Firstly, if savings are held as cash, rather than being loaned out (directly by savers, or indirectly, as via bank deposits), then loanable funds do not increase, and thus a recession may be caused - but this is due to holding cash, not to saving per se. Secondly, banks themselves may hold cash, rather than loaning it out, which results in the growth of excess reserves - funds on deposit but not loaned out. This is argued to occur in liquidity trap situations, when interest rates are at a zero lower bound (or near it) and savings still exceed investment demand. Within Keynesian economics, the desire to hold currency rather than loan it out is discussed under liquidity preference.

This is a better explanation than the one at liquidity trap. Basically, what's going on is that extreme liquidity preference would require negative interest rates in order for "savings not to exceed investment". As the zero lower bound makes that impossible (Ahem... See Negative interest rates: when are they coming to a central bank near you? by WIllem Buiter on May 7, 2009) then you find yourself in a liquidity trap where injections of money into the economy fail to stimulate lending.

The problem with the Wikipedia articles about economics, unlike the ones about, say, physics, is that the causal chains are not very clear in the mind of the article writers (possibly because the theory itself is broken).

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 19th, 2012 at 05:08:24 AM EST
[ Parent ]

The causal chain is unclear to the writers because they are not describing a causal theory, they are relating a just-so story.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 19th, 2012 at 06:35:57 PM EST
[ Parent ]

Or the banks could be getting cash from Central but are sitting on it because they know their paper is at least half garbage, and they need to make up the difference in case someone has the bad form to make a reserve audit.

by rifek on Thu Mar 22nd, 2012 at 06:11:53 PM EST
[ Parent ]

On the contrary, sitting on a time bomb would make them more inclined to gamble big rather than go home. After all, it is impossible to go double-bankrupt.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 22nd, 2012 at 08:49:05 PM EST
[ Parent ]

Oh, they aren't going home, they're playing Extend and Pretend: Phase II, in which they don't even have to cook their books to make the collateral look double what it is, they just use tax money to make it all look good.

by rifek on Fri Mar 23rd, 2012 at 07:22:29 PM EST
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Yeah, but extending and pretending doesn't get you out of the insolvency, it just prevents you from being resolved immediately. Sitting on shit until it matures doesn't, barring direct divine intervention, make it not-shit, let alone give it a gilt edge. If you want to dig yourself out of a serious insolvency, you need to make something happen to your balance sheet.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Mar 23rd, 2012 at 11:04:14 PM EST
[ Parent ]

You're forgetting the first rule of investment bankers: When it hits the fan, IBG-YBG (I'll be gone, you'll be gone.).

by rifek on Sun Mar 25th, 2012 at 12:33:45 AM EST
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It's what MIT school economists call it when you hit the zero bound of nominal interest rates. Since MIT school economists subscribe to the loanable funds fallacy, they believe that the central bank lowers interest rates by creating more liquidity, rather than creating more liquidity in consequence of its decision to lower interest rates.

The "liquidity trap," then, is the point where no amount of additional liquidity can reduce borrowing costs.

It's got nothing to do with liquidity, and it's not a trap. It's an operational constraint on the use of interest rate policy in macroeconomic planning. And it should not come as a surprise to anybody, but it repeatedly does, because neoclassical economists have an unhealthy infatuation with irrationally excluding discretionary fiscal and industrial policy from the realm of macroeconomic planning.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Mar 18th, 2012 at 01:50:24 PM EST
[ Parent ]

...neoclassical economists have an unhealthy infatuation with irrationally excluding discretionary fiscal and industrial policy from the realm of macroeconomic planning.

It probably goes down better with most to just instinctually reject those policies they know in their guts will provoke the ire of TPTB, or, especially, of those agents of TPTB who have influence over their careers. Gaffney showed rather clearly how this got started through the power of patronage over US private universities, it has been ongoing for over a century and Krugman's blindness to even the role of debt probably only seems willful.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Mar 18th, 2012 at 07:27:46 PM EST
[ Parent ]

Bloomberg Op-Ed: The Sorrow and the Pity of Another Liquidity Trap: Brad DeLong Jul 5, 2011

A financial crisis initiates a sudden flight to safety among bondholders -- widening interest-rate spreads, diminishing the private sector's desire to sell bonds to raise capital and encouraging individuals to save more and consume less as they, too, hunker down. Thus bond prices rise, and interest rates drop. As rates fall, firms see that they can get capital on attractive terms and so issue more bonds; households see the low interest rate earned on their savings and lose some of their desire to save. The market heads toward equilibrium.
...
In responding to a small financial disruption, the Federal Reserve can inject more money into the economy by buying bonds for cash, increasing the amount of cash so that even at the lower velocity of money we retain the same volume of spending. This eases the decline in interest rates, spending, employment and production into a decline in interest rates alone.
But when rates become so low that there's little difference between cash and short-term government bonds, open-market operations cease having an effect; they simply swap one zero- yielding government asset for another, with their hunger to hold more safe, liquid assets unsatisfied.
This is the liquidity trap.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Tue Mar 20th, 2012 at 01:02:27 PM EST
[ Parent ]

Starvid:

And trying to repair weak competitiveness with devaluations might work once, but it's hardly a long-term fix. See Sweden in the 70's and 80's.

I know that it is a common opinion that the 70's and 80's devaluations were bad, but the same time there is no opinion for abandoning the floating currency today. And the strong currency policy of the early 90ies was just a huge failure.

I suspect the 70's and 80's devaluations were really a sympthom of RoW catching up to Sweden. Skipping the carnage and destruction of ww2 is not an advantage that was going to last forever.

A vote for PES is a vote for EPP! A vote for EPP is a vote for PES! Support the coalition, vote EPP-PES in 2009!

by A swedish kind of death on Sun Mar 18th, 2012 at 04:00:52 PM EST
[ Parent ]

There is a crucial difference between devaluing within a fixed-rate system and floating your currency.

If you devalue in a fixed rate system, you have to defend the new, lower exchange rate, a rate which is prima facie incredible (you just devalued - why should anybody trust you to not do it again). Which means that you have to jack up interest rates almost as high to defend the new exchange rate as you had to to defend the old.

If you float, on the other hand, you are not committing to defending any particular exchange rate. So if people dislike holding your new, lower valued, currency, you can go "too bad, so sad" and keep the interest rate low for the benefit of your domestic industry.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Mar 19th, 2012 at 06:28:34 PM EST
[ Parent ]

1. You could either have a federal investment arm to create demand in times of need. This wouldn't be needed on a massive scale at all times,

Sure, it would only need to be maybe 2-5 % of total GDP when you average it over every year of operation.

as liquidity traps are rare,

Only if you run silly, growth-destroying interest rate policies like Taylor rules. Under a more sensible zero interest rate policy, you are always in a "liquidity trap." Because it's not actually a "liquidity trap." It the zero bound on nominal interest rates. Liquidity has nothing to do with it.

Alternately or complementary, you could create a strong federal financial regulatory agency to fight debt buildups, including in the private sector.

This requires a public sector able and willing to print and spend money as needed, in order to compensate for waxing and waning private demand.

2. A strong currency protects the purchasing power of consumers,

So what? Protecting the (purchasing) power of "consumers" is not an objective of left-wing policy. "Consumers" includes plenty of people whose interests are not ordinarily considered important in the formulation of left-wing policy.

making vital imports like gasoline, coffee, bananas (and foreign vacations!) cheaper,

At the cost of leaving a poorer country for the next generation. Foreign goods cost what they cost. You're not going to be able to change what they cost without fancy diplomatic footwork or old-fashioned gunboat diplomacy. When you use your "strong currency," so-called, to obtain cheap vacations, you are paying for those vacations with your children's wealth.

while imposing a powerful competitive pressure on the export industry, making it lean and constantly focused on improvement.

Because raising the average quality of your firms by destroying solvent and, on their merits, profitable going concerns because they are not profitable enough is obviously an awesome way to encourage industrial development.

- Jake

If you only spend 20 minutes of the rest of your life on economics, go spend them here.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Mar 17th, 2012 at 09:42:13 PM EST
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