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 
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.
11 comments
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Monday ~ September 26th, 2011 at 3:17 pm
anon
“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?”
The easiest answer: buy something else. Long-term bonds, or forex. In a pinch, have the government print more bonds to start a sovereign wealth fund. (Because the central bank has some problem with keeping risky assets on their balance sheet). Lather, rinse and repeat as needed.
Monday ~ September 26th, 2011 at 4:51 pm
Lord
Legalizing the money drop is the way to go. Nothing to fear from inflation because it provides the money to pay for it. Nothing to fear from debt because there is none.
Monday ~ September 26th, 2011 at 6:34 pm
IVV
I guarantee you that the only vacuum the average consumer worries about in the United States (or around the world, mostly) is taxes. Don’t raise taxes, don’t issue debt, and problem solved.
Tuesday ~ September 27th, 2011 at 5:12 am
reason
IVV – but that doesn’t help the unemployed.
Tuesday ~ September 27th, 2011 at 11:15 am
IVV
It helps them more than what they’re getting right now.
Tuesday ~ September 27th, 2011 at 5:13 am
reason
Karl,
YES – somebody finally gets it.
Tuesday ~ September 27th, 2011 at 5:14 am
reason
Bernanke forgot that the helicopter drop didn’t mean parking the helicopter on Wall Street.
Tuesday ~ September 27th, 2011 at 11:41 pm
Shaun Peterson
Hands clapping. Brilliant!
Thursday ~ September 29th, 2011 at 12:01 am
Harpreet Kaur
The policymakers should use unconventional monetary policy…..expanding the scale of its asset purchases or expand the menu of assets that it buys….such as buying long-term bonds and other assets….
Monday ~ October 3rd, 2011 at 9:15 pm
Edwin Perello
I’m just catching up on my RSS feeds, so I didn’t get to read this until now.
Karl, have you read this from Peter Frase and Steve Waldman?
http://www.peterfrase.com/2011/09/the-basic-income-and-the-helicopter-drop/
“We should try to arrange things so that the marginal unit of CPI is purchased with ‘helicopter drop’ money. That is, rather than trying to fine-tune wages, asset prices, or credit, central banks should be in the business of fine tuning a rate of transfers from the bank to the public. During depressions and disinflations, the Fed should be depositing funds directly in bank accounts at a fast clip. During booms, the rate of transfers should slow to a trickle. We could reach the ‘zero bound’, but a different zero bound than today’s zero interest rate bugaboo. At the point at which the Fed is making no transfers yet inflation still threatens, the central bank would have to coordinate with Congress to do ‘fiscal policy’ in the form of negative transfers, a.k.a. taxes. However, this zero bound would be reached quite rarely if we allow transfers to displace credit expansion as the driver of money growth in the economy. In other words, at the same time as we expand the use of ‘helicopter money’ in monetary policy, we should regulate and simplify banks, impose steep capital requirements, and relish complaints that this will ‘reduce credit availability’. The idea is to replace the macroeconomic role of bank credit with freshly issued cash.”
Tuesday ~ October 4th, 2011 at 3:30 pm
idara essang
The problem with the economy is currency insufficiency. There is vast wealth of products and services for all consumers but money is not available to consume or produce them. Currency insufficiency begins with the fact that the economy is only partially nonetized. In early Mideast marketplaces when merchants had large volume and variety of goods to trade, they made clay plates depicting the qty and image of the product, whether one had 10 cows or 1barrel of wheat, and so on. The clay plates were traded btw the merchants for assets of comparable value and the actual products were later delivered . This was a viable system of trade bec each asset was automatically monetized. Everyone’s who owned an asset automatically had money to trade it for another asset of value. In modern markets where banking is centralized, there is only partial monetization. Money created by the Fed and credited to banks is lent to create limited goods, various material goods and services are made and consumed. Those individuals involved in manufacturing of goods have money to consume, and the limited earnings of companies and wages of workers consumes only limited range of goods and services so optimal employment is not possible. There is competition for money caused by the initial problem of partial monetization, but subsequently exacerbated by market forces such as Inflation, profit hoarding by few wealthy CEOs, outsourcing, open trade, immigration, lack of innovation, gov fiscal policy. These forces cause the market to be undercapitalized, so there are vast supply of goods and services to produce and consume, but money is not available to do so. The thing to do is to prohibit inflation by law for vital market assets and commodities. Things that are essential for survival are subject to inflation bec consumers have no choice not to consume. Rent, healthcare, higher education, energy, defense assets at high prices limit consumption of those goods as well as of nonessential goods, so that the jobs that would exist in all industries do not, even though labor, materials and demand exist money does not. Gov ends up extracting taxes to fund vital needs for the people that are unemployed. These goods are at increasing cost, and growing number of citizens and immigrants need the subsidies. The tax monies go to same few suppliers of vital assets, and is not spent back in proportion in the economy. The subsidies allow Inflation to persist in primary market assets which is key cause of unemployment. Inflation, outsourcing and the other mechanisms continue to limit employment and consumption which are the things taxes come from. Gov ends up with budget deficit, resorts to selling bonds. But the market does not generate enough taxes to pay off the bonds so gov ends up in bond debt also. So now Even though there is vast supply, labor, technology and gov has power to create money by fiat, there is unemployment, poverty and massive debt bec free market capitalism is not an effective trade system. Read solutions at ECONOMYFIXED.WEBS.COM for real solutions.