Saturday, November 20, 2010

Anatomy of Balance Sheet Recession

There are three PowerPoint presentations available from the above link that reflect the issues in the world economy and the role of monetary policy in stimulating the US economy. This is a summary of the issues as I see them. The basic problem is that we have a balance sheet recession. Businesses and households took on too much debt and they are saving more and paying off their debt. The result is what we call the paradox of thrift. If everyone increases savings at the same time, spending collapses and we have a recession. This is reflected in the presentations by very weak private demand for loans despite extremely low interest rates. The only way to fix this problem is for the public sector to absorb the flow of savings by borrowing and spending. In other words, we need to use fiscal policy to stimulate the economy. Unfortunately, it is politically impossible to use fiscal policy in the US because of the fixation that conservatives have on federal budget deficits and the longer term problem of the national debt burden. Frankly, I believe that their concern with budget deficits is both misplaced and politically motivated. It fits into the "starve the beast" tactic advocated by many conservatives, which uses the deficit as an excuse to cut spending on social programs. Also a poor economy will increase GOP chances to win back the presidency in 2012. In other words, the public interest is being sacrificed for party interest.

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