Liquidity? I seem to recall it.

Posted on August 1, 2011

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Things used to be so much easier. Democrats would raise taxes, then Republicans would cut them. Democrats would spend money, then Republicans would cu…. sorry couldn’t finish that with a straight face. OK, so the dynamic hasn’t really changed that much but with a deal on the entirely unnecessary fight over the debt ceiling focusing entirely on cuts to services it does seem to have shifted Washington into a rather curious phase in its pathetic existence.

As has been noted by countless economist far better paid than I, reduction in government expenditure while consumer demand can’t retain positive figures is a severe threat to the stability of the economy.  We are currently stuck in a liquidity trap which in combination with high unemployment and consequently low demand, leaves us in that stickiest of scenarios – a depression. It’s not some quasi-empirical logic puzzle, if you want people to spend money you have to give them money to spend. How you give them the money isn’t that hard to figure out either, what with infrastructure across the United States bordering on ‘war torn’ condition.

Now our detractors and seemingly everyone in Washington bar the progressive caucus will argue that the US government cannot afford to spend any more money on rebooting the economy, now while it certainly is the case that there is a large federal deficit that should be addressed at some point, it is remarkably naïve to think that the US cannot pay more than its GDP for a few years, indeed during World War II the US was in debt at over 120% of its GDP and because it was paid for through special bond issues known as Liberty Bonds it was paid off as soon as the war was over because the war wasn’t costing the country any more and production was so high, i.e. GDP was so high.

The problem with cutting government spending now isn’t just that it will reduce aggregate demand through some abstract macroeconomic monetary policy, right now government demand is the only thing that’s stopping the economy from regressing, prior to the stimulus the liquidity trap had the entire global economy freefalling and government spending put a spanner in the works. Removing the spanner now won’t free up the markets to fantastical growth, where’s it going to grow into? Without consumer demand who’s going to buy whatever businesses make more than they already are? So long as consumer demand is still depressed we are at constant risk of spiraling out of control again, yet with an option that has been used to fund both world wars, reinvest in the economy following the great depression and rebuild after 9/11 we have the means to grow our way out of debt if someone steps up to the plate and gets it done.

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Posted in: Economy