Re: [Pen-l] Liquidity trap

[Jim Devine <jdevine03@xxxxxxxxx>]

David Shemano wrote:
> A "liquidity trap" implies, to me, an irrational decision not to borrow and lend based upon prevailing interest rates.  <

When Keynes first developed the concept, he wasn't saying that people
were irrational. Instead, there were clear limits to rationality as
applied in the real world, because of the existence of fundamental
uncertainty (uninsurable risk).

> After an extended credit bubble, the overall market is deleveraging, i.e. reducing indebtedness.  Leveraged consumers presently not demanding loans and trying to reduce indebtedness is not irrational.  Banks changing credit policies to make loans only to solvent borrowers that will be repaid is not irrational.  Insolvent banks holding on to cash instead of loaning it out in order to address creditor and depositor demands is not irrational.  Businesses projecting slower consumer demand and therefore reducing borrowing is not irrational.  There is no liquidity trap [as David defines it] -- the market is shouting at the top of its lungs it wants to deleverage.<

The problem, of course, is the usual one seen in serious economics:
individual rationality leads to collective irrationality. Everyone
seeks to deleverage (because that serves individual self-interest,
i.e., is "rational" in economics books) but that makes the financial
system and the rest of the economy collapse. Thus, people not involved
in the financial system's misbehavior (its earlier over-leveraging,
which was also individually rational given the lack of serious
regulation, which is what the financial lobbyists wanted) nonetheless
end up being punished with high unemployment, bankruptcy, and the
like.

> The only irrational behavior is that of the politicians trying to stop the deleveraging.  All policy that is intended to prevent deleveraging (i.e. increase borrrowing) at this time is based upon the theory that the problem  with the credit bubble wasn't the existence of the bubble, but that the bubble ended.  That is irrational.<

Maybe, but that does not deal with the collateral damage that results
from the financial bomb going off, the way in with Madoff, Thane,
Stanford, and similar scam artists (along with a large mass of minor
financiers seeking profit and profit by over-leveraging) end up
imposing costs on the rest of us. And the vast majority of these
scamsters and gamblers aren't going to be held responsible on the
dock.

It may make sense to let the bubble pop completely, following the lead
of the famous politician Andrew Mellon ("Liquidate labor, liquidate
stocks, liquidate the farmers, liquidate real estate").  Marx,
Schumpeter, and the so-called Austrian economists pointed to the way
recessions purge imbalances from the economy, allowing for renewed
accumulation and prosperity in a normal business cycle. But last time
the political elites in the US and much of the rest of the rich
capitalist world followed Mellon's path (during a crisis of similar
magnitude),  the economy's roller-coaster car spun off the track.

Perhaps David is arguing that we need a new Great Depression, because
from a ultra-left perspective, "the worse the better": a Depression
will automatically spur the proletariat to organize and fight, to
expropriate the expropriators.
-- 
Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own
way and let people talk.) -- Karl, paraphrasing Dante.
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