Thursday, October 20, 2011

monetary vs fiscal policy

Paul Krugman and Brad Delong are talking about how to get the economy running again, but they're economists so they immediately start talking about models, expectations, interest rates, etc. I'm not an economist (even after reading several textbooks), so that doesn't do much for me. Models necessarily abstract the real world, and while they can teach us a great deal by doing so, they leave a lot out. And sometimes, what they leave out is as important as what they tell us.

When Krugman and Delong say we're in a liquidity trap, they talk about models, graphs, equilibrium points, and other mathematical concepts. They rarely talk about what a liquidity trap means in terms of individual actors. If low interest rates can't stimulate the economy, it means that 1) the low interest rates don't affect consumption, and 2) low interest rates don't affect investment. In the first case, that probably means that the low interest rates we see in bond markets aren't, in fact, getting passed through to consumers. In the second case, it may mean that businesses aren't seeing low interest rates, or it may mean that even with low-interest loans, businesses aren't seeing opportunities for profitable investments.

So, what do consumer interest rates look like? Mortgage rates are low, but the housing market is so soft that investing in a house looks like a risky proposition, even with a low interest rate. People may refinance and reduce their expenses, but low rates don't appear to be creating new home owners and driving new construction. Credit card rates, on the other hand, aren't anywhere near zero. We aren't even close to a lower bound there. Low interest rates at the Fed and T-Bill level may not be doing anything to stimulate consumer demand.

I'm too lazy and unskilled to figure out the interest loans a typical business might face, but there's ample evidence that even with low interest rates, businesses don't see many investment opportunities. Businesses sitting on record piles of cash don't need loans. They have money to spend. They must not see anything worth spending it on.

The advantage of fiscal over monetary policy in times like this is that fiscal policy acts directly, without having to go through intermediaries that have to be profitable. Unlike a business, the government can spend money without worrying about whether the investment will be profitable. When demand is slack, it can even do so without worrying about driving out private activity. Unlike a bank, the government can give money to consumers without worrying about whether they can pay it back, and it can do a much better job of making sure that the funds it injects go to those who will spend it.

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