Steven Landsburg asks

Why aren’t you thrilled with the current state of the economy?

Here’s why I ask: According to what I take to be an orthodox Keynesian view, we are now in a liquidity trap. (My question does not apply to Keynesians, new or old, who believe otherwise.) That means that people want to hold lots and lots of money instead of spending it. Cool! We can provide money at almost zero cost. So it should be easy to make people very happy. What’s the problem?

I love these types of questions. They are simple and piercing. Steven adds a bit of extra that we could discuss but I think its worth answering his question directly.

The problem is getting money to the people. We can produce money at zero cost, but we need some distribution method.

Our normal distribution method is to use the money to buy government bonds. This is called monetary policy. The money then spreads out to the people via the magic of interlocking markets and makes everyone happy. Yea Smile

However, sometimes that mechanism gets broken. The market works on the basis of prices. Yet, the prices of bonds are not infinitely flexible. Once, the yield on bonds goes to zero it can’t go any lower – or to keep things perfectly straight, the price of the bond can’t go higher.

Thus efforts to buy lots of bonds do not wind up pushing up bond prices and send money through the interlocking web of markets. It simply winds up with more money collecting on bank balance sheets.

So what to do?

Well, there are a number of things but one really straight forward thing to do is use the mail system instead of the bond markets.

In this case what we would do is place the money into envelopes and mail them to the people around the country. There are always going to be fights over who should get mailed how much but this is the basic idea.

This is also known as a “helicopter drop” because of its like you went around the country in a helicopter dropping money.

Now I think all Keynesians agree that the Helicopter drop would work if that was the end of the story. The problem is that Central Banks have a tendency to want to vacuum up excess money because of concerns about inflation.

If people think the Central Bank is going to come around with a vacuum cleaner and simply suck-up all the money that got dropped, they’re desire to hold money will increase exactly in proportion to the amount of vacuuming the expect.

In some cases people suspect that the Central Bank will vacuum up every single dollar it dropped. In those cases, the dropping doesn’t make anyone happier because they are just going to get hurt again by the exact same amount.

This is a liquidity trap.

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