What’s the Magic Bullet?

By all means go over and read Kenneth Rogoff’s latest op-ed over at Financial Times. In it he notes that in the war against the economic slump we’re in we have not yet begun to fight or at least not yet begun to fight effectively:

Everyone agrees that bold action is required, but what kind of bold action? It is far from clear that any huge temporary fiscal stimulus will rev up the engine enough to achieve self-sustaining growth. Higher government debt adds an overhang of higher expected future taxes on top of pre-existing private debt overhang. True, in the classic analysis of a zero interest rate liquidity trap, the ideal policy is a money-financed temporary surge in government spending. But the canonical model completely ignores debt overhang.

The most direct remedy, of course, would be to find expeditious approaches to cleaning up balance sheets whilst maintaining the integrity of the financial system. In the case of Europe, this involves very large debt writedowns in the smaller periphery countries, combined with a German guarantee of central government debt in the rest. In return, Germany will have to receive a disproportionate share of fiscal power in a more deeply integrated union, for at least as long as it is making substantial transfers. In the case of the US, policymakers need to offer schemes to write down underwater mortgages, perhaps in return for other concessions such as giving the lender a share of any future home price appreciation.

He further suggests effecting moderate inflation, i.e. debasing the currency, and engaging in structural reforms to social programs.

Recommended reading.

Unfortunately, the sides are chosen, the battle lines are already drawn, and you’ve got one side attacking anything other than massive fiscal stimulus as idiotic and the other decrying their opponents as socialists. Increasingly, the world is reminding me of an old Star Trek episode “Let That Be Your Last Battlefield” in which old enemies are so committed to their age-long conflict that they can’t see anything else.

10 comments… add one
  • Icepick Link

    I heard at least two other economists yesterday (didn’t catch their names) recommending (presumably moderate) inflation. I thought that was really easy for them to do, not so much easy for most of us to stomach. Because with unemployment this high there sure as shit won’t be any wage inflation for at least 95% of the working population. (Not to mention those of us without any income whatsoever.) Once again, we’ll get squeezed, while the asset rich class gets off with trillions more in appreciation.

  • Once again, we’ll get squeezed, while the asset rich class gets off with trillions more in appreciation.

    Typically, inflation is a wealth transfer from savers to debtors. And this is how the Great Depression ended, according to some, and economic growth took off. Granted improvements in the labor market were surprisingly moderate by comparison, but hopefully that was due to FDR’s boneheaded policies of trying to raise prices by cutting output and creating cartels.

  • Icepick Link

    Oh, inflation could help out everyone with debt problems (which are most of us), but only if there’s wage inflation too. I just don’t see that happening.

  • That depends on if you think labor markets are competitive or not. Competitive labor markets will likely keep pace with inflation, if not they wont.

  • Icepick Link

    I don’t see how the labor market can be competitive with UE up around 11% (after factoring-in the drop-outs). We’ve had wage stagnation for decades now, even though there has been (low level) inflation. I don’t see either of those things changing any time soon.

  • steve Link

    Moderate inflation, debt financing (he increased our debt from $900 billion to $2.6 trillion) and a weakening dollar were key parts of the Reagan recovery.

    I think that I would prefer haircuts all around, but I am still not sure which, if any, of our large banks are really solvent, so that does worry me.


  • Icepick Link

    Steve, there was more wiggle room on increasing the debt back then, IIRC. We weren’t nearly at the levels we are now in relative terms.

    Moderate inflation is more likely to work for the peons (such as myself) if wages also inflate. Not sure that they did so enough during the Reagan years, but there’s no reason to believe they will now at all.

    And good luck weakening the dollar when every other currency in the world is either (a) pegged to the dollar directly or (b) is already seeking to devalue itself in terms of all other currencies. It’s a race to the bottom for currency devaluation, and it looks like we’ll lose (amongst the big players) because as bad as things are here, things seem to be worse elsewhere.

  • PD Shaw Link

    “as bad as things are here, things seem to be worse elsewhere”

    I think I inadvertantly created a crisis of faith in explaining to someone how the S&P downgrade probably increased the value of U.S. debt by freaking people out about the state of the world economy. I could almost see the thoughts forming in a balloon over his head: “need gun, need bullets!”

  • Icepick Link

    I could almost see the thoughts forming in a balloon over his head: “need gun, need bullets!”

    He’s only figuring that out now? Neophytes….

  • Sam Link

    but only if there’s wage inflation too.

    I think you can’t have one without the other, i.e. it’s very hard to create inflation right now. Every time oil prices go up we crash again, likely because of your point – no one gets a raise to be able to sustain inflation.

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