Krugman on the Deflation quagmire

[pdavidso <pdavidso@xxxxxxx>]

Krugman {Fear of Quagmire?, New York Times5/24/2003] suggests a frightening
scenario regarding world-wide deflationary tendencies, which he ascribes to
a"liquidity trap". His solution that (1) the Fed should "announce an inflation
target" and (2) the European Central Bank should reduce interest rates more in
line with Federal Reserve reductions. The evidence suggests that these two
policies are insufficient.  The inflation targeting idea merely implies that
the Fed announce that it will more rapidly expand the money supply if the
economy falls below the target. But Krugman has already suggested that in a
liquidity trap this approach will fail since "additional money pumped into the
economy...sits idle".  Moreover, the cooperation of other Central Bankers to
lower interest rates did not help Japan out of its decade long liquidity trap
when the most important central bank in the world, the Federal Reserve,
continually slashed its interest rates since 2000.
	The Bush Administration has also recommended two solutions. First, tax cuts
to the rich, which, as Krugman suggests, is likely to be insufficient since it
provides additional funds to those"least likely to spend".  The second policy
solution is Treasury Secretary Snow's attempts to talk down the dollar to
stimulate US exports. Even if successful, talking down the dollar (and thereby
raising the Euro) will export to the Euro nations US unemployment as well as
exporting unemployment to Europe of the other nations whose currency is tied
to the dollar. It will also export some of the deflationary forces in the US
to Europe as our exports become cheaper to Europeans.  With the German economy
already in decline, that is the last thing we should be trying to do.
	A similar deflation quagmire infected the global economy in the Great
Depression. The problem underlying what Krugman calls a "liquidity trap" is
one of a lack of global demand for the products of industry. The solution
advocated by Keynes in the 1930s is still applicable today. Keynes wrote that
when monetary policy alone cannot induce the private sector to spend, there is
a need for what Keynes called the  "socialization of investment", meaning not
that the State should own the means of production but rather the government
should use all sort of "devices by which public authority will cooperate with
private initiatives" to increase the productive facilities that are the
backbone of our economy ? even if this means running perpetual deficit capital
account spending.
	The US government sees as the only solution for growing the floundering Iraqi
economy the "socialization of investment" where the government contracts with
private enterprises (Bechtel and Haliburton and their subcontractors) to build
up the Iraqi infrastructure and oil production facilities.  Why is not
desirable to have a similar government investment spending policy (even if it
means deficit spending) to promote the improvement of the infrastructure and
other productive facilities in the United States?

Paul

Paul Davidson
Editor, Journal of Post Keynesian Economics
University of Tennessee
SMC 503
Knoxville, Tennessee 37996-0550
office phone #;(865)974-4221; office fax# (865)974-1686 or (865)974-4601
home phone and fax # (865)692-0802
email pdavidson@xxxxxxx
http://econ.bus.utk.edu/davidsonextra/Davidson.html