Sunday, April 10, 2011

Brad DeLong: Richard Koo Is Right

Prof. Brad DeLong tell us that the basic principles of monetary economics are nothing new.

"Take, say, yesterday morning's panel with Carmen Reinhart and Richard Koo--both were making arguments the logical structure and framework of which seemed to me to be straight out of Walter Bagehot's Lombard Street. And Lombard Street was published in 1873.

"Richard argued that--just as in Japan in the 1990s--the collapse of asset values had created a world desperately short of financial assets, in this particular case savings vehicles of moderate and long duration. The impairment of balance sheets thus left households and businesses anxious to cut back on their spending in order to rebuild their balance sheets. Since the interest rate could not fall any further to clear the market for savings vehicles, recession followed. The recession would, he said, last until and unless the supply of financial assets to serve as savings vehicles rose to levels consistent with financial-market demand. And government could materially accelerate this process if it stood up while the private sector was standing down: if it spent, invested, and borrowed in order to boost the market supply of savings vehicles."

Brad concludes:

"My view is that Richard Koo is right, and economic core governments should be frantically engaging in expansionary fiscal policy right now until the wake-up call from financial markets comes, and then they should stop.

"The main takeaway point, however, is that this is all the macroeconomics of 1873."

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